It sounds benevolent to say we ought to reduce economic inequality. When you phrase it that way, who can argue with you? Inequality has to be bad, right? It sounds a good deal less benevolent to say we ought to reduce the rate at which new companies are founded. And yet the one implies the other.
Indeed, it may be that reducing investors' appetite for risk doesn't merely kill off larval startups, but kills off the most promising ones especially. Startups yield faster growth at greater risk than established companies. Does this trend also hold among startups? That is, are the riskiest startups the ones that generate most growth if they succeed? I suspect the answer is yes. And that's a chilling thought, because it means that if you cut investors' appetite for risk, the most beneficial startups are the first to go.
Not all rich people got that way from startups, of course. What if we let people get rich by starting startups, but taxed away all other surplus wealth? Wouldn't that at least decrease inequality?
Less than you might think. If you made it so that people could only get rich by starting startups, people who wanted to get rich would all start startups. And that might be a great thing. But I don't think it would have much effect on the distribution of wealth. People who want to get rich will do whatever they have to. If startups are the only way to do it, you'll just get far more people starting startups. (If you write the laws very carefully, that is. More likely, you'll just get a lot of people doing things that can be made to look on paper like startups.)
If we're determined to eliminate economic inequality, there is still one way out: we could say that we're willing to go ahead and do without startups. What would happen if we did?
At a minimum, we'd have to accept lower rates of technological growth. If you believe that large, established companies could somehow be made to develop new technology as fast as startups, the ball is in your court to explain how. (If you can come up with a remotely plausible story, you can make a fortune writing business books and consulting for large companies.) [5]
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.
I realize startups are not the main target of those who want to eliminate economic inequality. What they really dislike is the sort of wealth that becomes self-perpetuating through an alliance with power. For example, construction firms that fund politicians' campaigns in return for government contracts, or rich parents who get their children into good colleges by sending them to expensive schools designed for that purpose. But if you try to attack this type of wealth through economic policy, it's hard to hit without destroying startups as collateral damage.
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?
A friend of mine who knows a lot about computer security says the single most important step is to log everything. Back when he was a kid trying to break into computers, what worried him most was the idea of leaving a trail. He was more inconvenienced by the need to avoid that than by any obstacle deliberately put in his path.
Like all illicit connections, the connection between wealth and power flourishes in secret. Expose all transactions, and you will greatly reduce it. Log everything. That's a strategy that already seems to be working, and it doesn't have the side effect of making your whole country poor.
I don't think many people realize there is a connection between economic inequality and risk. I didn't fully grasp it till recently. I'd known for years of course that if one didn't score in a startup, the other alternative was to get a cozy, tenured research job. But I didn't understand the equation governing my behavior. Likewise, it's obvious empirically that a country that doesn't let people get rich is headed for disaster, whether it's Diocletian's Rome or Harold Wilson's Britain. But I did not till recently understand the role risk played.
If you try to attack wealth, you end up nailing risk as well, and with it growth. If we want a fairer world, I think we're better off attacking one step downstream, where wealth turns into power.
[1] Success here is defined from the initial investors' point of view: either an IPO, or an acquisition for more than the valuation at the last round of funding. The conventional 1 in 10 success rate is suspiciously neat, but conversations with VCs suggest it's roughly correct for startups overall. Top VC firms expect to do better.
[2] I'm not claiming founders sit down and calculate the expected after-tax return from a startup. They're motivated by examples of other people who did it. And those examples do reflect after-tax returns.
[3] Conjecture: The variation in wealth in a (non-corrupt) country or organization will be inversely proportional to the prevalence of systems of seniority. So if you suppress variation in wealth, seniority will become correspondingly more important. So far, I know of no counterexamples, though in very corrupt countries you may get both simultaneously. (Thanks to Daniel Sobral for pointing this out.)
[4] In a country with a truly feudal economy, you might be able to redistribute wealth successfully, because there are no startups to kill.
[5] The speed at which startups develop new techology is the other reason they pay so well. As I explained in "How to Make Wealth" (in Hackers & Painters), what you do in a startup is compress a lifetime's worth of work into a few years. It seems as dumb to discourage that as to discourage risk-taking.
Thanks to Chris Anderson, Trevor Blackwell, Dan Giffin, Jessica Livingston, and Evan Williams for reading drafts of this essay, and to Langley Steinert, Sangam Pant, and Mike Moritz for information about venture investing.
What I Did this Summer
The first Summer Founders Program has just finished. We were surprised how well it went. Overall only about 10% of startups succeed, but if I had to guess now, I'd predict three or four of the eight startups we funded will make it.