As Paul understands that we're all connected (you can't pull on one part of the bed-sheet with out pulling on the rest of the bed-sheet), he hasn't made the connection that if one side of the bed is dragged into being a shit-hole, the rest of the bed will eventually be a shit-hole, as it's all connected. In South America, for example, kidnapping is such a huge problem. The effect is to make these places less nice for the wealthy as well as the poor.
A lot of times the policies that reduce inequality aren't kill all the start-ups/crazy take all the money from rich people policies. Often their simple things that don't take a ton of money like head start funding, lower the cost of post-secondary education and training, and providing certain basic services like health care. What the US has done is to look at balancing the budget by reducing taxes on the very wealthy (upward pressure on income inequality) while taking money from programs that reduce equality.
There's a belief that most people who are poor are not working. Actually, many of them work quite hard. But washing machines work hard, too. Simply working hard doesn't get you ahead. In some cases there's a fair amount of luck involved. I sometimes look at the startup economy a little bit like pulling the slot lever. You can do everything right, but a lot of things still have to go well (some of which are outside of your control) before you cash out. Paul rightfully calls this risk, meaning that it's not guaranteed that an investor will get his pay out and it's far from guaranteed a founder will get rich. But it's bizarre to think keeping the US from sliding into an economic hell-hole will somehow destroy that slot-machine economy.
What is 'head start'?
It's an early childhood learning program. Nothing's perfect but it has a pretty good track record.
1. Reducing the potential payoff kills startups (and)
2. To reduce inequality, you have to reduce the payoff of startups
2 is false: there are many ways to reduce inequality that dont affect startups. Take inherited inequality: you can tax inheritance, you can make college more affordable (by, say, using the inheritance tax), you can tax only big companies, or real estate. All these things reduce inequality. If inequelity is bad, we might fight it in some places, and still tolerate the existence of "the next bill gates"
1. is weird. I dont know for you, but for me, there is a clear upper ceiling of incentive: I'd work hard for a million, but not so much for my eleventh million. I am not sure founders are just multiplying P(sucess) and payoff. (VCs might be, though)
The problem with this is that works great when you have a large number of relatively cheap startups all trying to be the next app fad. But that model fails miserably for anything that requires a large up-front investment that might not pay off. Nobody can afford to fund 100 Tesla's and hope that one works. The initial cost is too large and the investment payoff will never cover the rest anyway.
And that's why there aren't many Teslas and there are thousands of social apps. Is that the desirable outcome that we're trying to preserve using inequality?
Paul Graham is right in that if you tax wealthy people there will be less money for startups. But whether that's a good or bad thing considering the alternatives is another discussion.
There's a neglected factor here, and that's founder risk. If I have no money, I won't be able to start a startup unless someone else gives me some; it's too risky and I might starve quickly. But if my basic health and survival needs are met, there's a lot less risk. We don't consider health care and welfare as enabler for growth in the U.S. but maybe we should. How many college-grad founders would bootstrap companies if they didn't have to worry about how to keep the lights on, and there was a potential for a long term payoff of a few million dollars?
Wow, I never looked at it that way but it makes so much sense. I always wondered why supposedly pro-entrepreneurial factions so heavily cheered policy that would increase payouts while simultaneously slamming social policy that would decrease activation barriers when, to me, the latter seemed like it would be much more effective at achieving the goal of increasing entrepreneurship (what with the reduced transaction costs of bootstrapping and all).
Now I get it. Not only do they not care about entrepreneurship which they can't get a cut of, it threatens their business model.
"if there was no possibility to get rich, there would be no startups".
Does not explain patronage, i.e. people investing in people for reasons other than getting rich.
"without start-ups, there would be slower rates of technological growth".
Prizes, like the Ansari X-Prize, is another model that drives innovation, it can be viewed as a low-risk investment.
Essay on PG's website here: http://www.paulgraham.com/inequality.html
https://www.google.com/search?q=inequality+site%3Ahttp%3A%2F%2Feconomistsview.typepad.com
https://www.youtube.com/watch?v=RpD_Sz_ZWPk&t=775
explains the most of it for a bureaucratic politician. The rules one make in society will tick (in the eye of the common folk) the balance for risk taking. Most of Europe is plagued by this social condition that Mr. Graham describes in here.
Addition: The scope of Paul Graham's talk is only of relating the economic risk-taking with inequality, but it would pay to give a deeper thought to the company-founding phenomenon. Economic ground poisoning (through patent trolling or regulation hammering) is also a very important factor to it, and that is something that can be fixed also only on political levels.
How do you push down on the top? You could try to decrease the productivity of the people who make the most money: make the best surgeons operate with their left hands, force popular actors to overeat, and so on. But this approach is hard to implement. The only practical solution is to let people do the best work they can, and then (either by taxation or by limiting what they can charge) to confiscate whatever you deem to be surplus.
So let's be clear what reducing economic inequality means. It is identical with taking money from the rich.
When you transform a mathematical expression into another form, you often notice new things. So it is in this case. Taking money from the rich turns out to have consequences one might not foresee when one phrases the same idea in terms of "reducing inequality."
The problem is, risk and reward have to be proportionate. A bet with only a 10% chance of winning has to pay more than one with a 50% chance of winning, or no one will take it. So if you lop off the top of the possible rewards, you thereby decrease people's willingness to take risks.
Transposing into our original expression, we get: decreasing economic inequality means decreasing the risk people are willing to take.
There are whole classes of risks that are no longer worth taking if the maximum return is decreased. One reason high tax rates are disastrous is that this class of risks includes starting new companies."
Paul Graham
Let's say I wanted to maximize the set of technology ideas that could turn into profitable businesses, without worrying about the economics of whether businesses founded on those ideas would be funded to the point where they could enter widespread use. I would attempt to give people from every walk of life, every possible perspective, the opportunity to educate themselves about the mechanisms behind how their world works, and to learn to think innovatively in groups - in many ways, this is what college, business school, and business mentorships are designed to do. In other words, to maximize the set of technology ideas, I maximize the diversity of idea generators.
In this sense, a world in which income inequality is unregulated is a world where the diversity of idea generators is sub-optimal. A world of slum-like conditions is not conducive to raising a generation of engineers, I would think.
The problem, of course, is that it's much more difficult to quantify how diversity translates into plausible ideas, than it is to quantify how taxation moves the threshold of how risky a startup can be. Perhaps a study of the economic background of founders, weighted by their companies' contributions to GDP, would be beneficial.
In the speech, PG says "What's the right relationship? God only knows. It's enough for me to point out that this relationship exists." That's nice, but one should also point out that there's more to the "relationship" than just the funding side of things.
"If you want to reduce economic inequality instead of just improving the overall standard of living, it's not enough just to raise up the poor. What if one of your newly minted engineers gets ambitious and goes on to become another Bill Gates? Economic inequality will be as bad as ever."
So what is the more important goal to raise the overall standard of living or reduce economic inequality?
Ideally inequality shouldn't matter. Poverty should matter, but why should it matter if someone has billions of bucks?
But our world is not "ideal."
The problem with inequality is what happens when you have enormous excess savings at the top. It has to go somewhere, since sitting in cash is almost never the best thing to do with a lot of money. A deflationary currency would let it sit in cash, but that would also have a negative effect on all forms of investment since it makes cash a "sure thing."
Ideally it should go into productive investments: new companies, investments in expansion of existing ones, R&D, etc. Some of it certainly does, and this is what's driving the present boom in seed funding, VC, and other beneficial things.
But again, our world is not ideal. There is not an unlimited supply of good investments. If the amount of money saved exceeds the supply of good investments, only two things can happen: (1) it chases bad investments, and (2) it inflates asset bubbles.
(1) results in investors losing most or all of their investments, so investors are going to shy away from that. Why would you invest money in something with no chance of success? So as the investment market gets saturated, there's going to be a limit to the extent to which investors are willing to lower their standards. They might take somewhat more risk, but they're not going to invest in what they see as obvious losers.
That leaves (2), and that's where things get ugly. In short: your surplus savings is why I can't afford a house. Your savings are hurting me. They shouldn't, but they are.
Surplus savings get dumped into idle assets that seem as if they're likely to hold value: real estate, commodities, etc. This inflates the cost of those assets, effectively imposing something like a tax on those who actually need and use those assets. Now people have to take out bigger mortgages, or even if they're cash buyers they have to lock up more and more of their personal wealth in their home in order to afford the artificially inflated prices demanded by the market. They have to work harder and longer for less real payoff in order to prop up the savings of the super-rich.
As this continues, there's less and less money available in lower echelons of society for other things. This in turn results in less profitable investments. Why invest in building new businesses when there are no customers for those businesses? It's a vicious cycle: higher rents and asset prices lead to less disposable income which leads to less opportunity for new businesses which leads to a worse investment market which leads to more money being parked in rentier assets.
Eventually you end up with a true feudal society: huge amounts of money at the top and everyone else as renters. Only the nobility can afford to actually "own" anything, as any own-able durable asset has become a bank account for parking surplus savings.
Edit:
Returning to (1) and (2) above -- chasing bad investments vs. inflating asset bubbles -- what we've seen has been a progression from (1) to (2). As inequality exploded in the 90s, it first inflated a VC and stock market bubble. Then this bubble popped and all that money ran into real estate and other rentier assets, inflating these to sometimes ridiculous degrees. There was a partial pop of the real estate bubble but it was rapidly backstopped by the state, since at this point the choice was between a perpetually inflated asset bubble and a great depression.
The current reality is "in-deflation": inflation in everything you need (a.k.a. rentier assets), deflation in everything else (a.k.a. produced goods). It's possible that we'd be better off now if they'd let it all burn in 2008, essentially destroying all this surplus paper wealth. But it's hard to say.
Edit #2:
I wonder if these problems would exist if humans lived longer? Keynes correctly describe what I outlined above as "savings in excess of planned investment," and life span effectively limits our ability to plan investments.
There are tons of great investments that could easily soak up all of today's surplus savings, like terraforming Mars or sending interstellar probes in search of extraterrestrial trading partners for example. But who's going to invest in something that wouldn't see a return for 10,000 years?
That's what makes Elon and others like him stand out among their rich cohorts: they invest like immortals.