Tim O'Reilly schools Paul Graham on inequality

Y Combinator founder and essayist Paul Graham's essay on the inevitability — and desirability — of income inequality sparked many scathing rebuttals, some of them quite brilliant, but the best so far comes from Tim O'Reilly, one of technology's towering figures.

O'Reilly provided some prepublication comments on Graham's essay, but it wasn't until after its publication that he was able to write a complete set of comments on the piece. O'Reilly quietly and calmly torches Graham's many straw-men, and turns his essay into something much smarter, more nuanced, and critical, drawing a distinction between wealth from the financial sector and the real economy.

When a company fails to deliver value that lives up to that bet, but still cashes in through IPO or acquisition, the wealth that is gained by startup founders and early investors is taken from public market investors. This is a risk that both sides of the bet willingly take, and it has provided enormous fuel for innovation as it encourages innovators to take risks in hope of future rewards. But in over-excited markets, it's too easy for many startups to aim to cash out with "dumb money" while the getting is good with no real plan for ever delivering real revenues or profits.

In an earlier era, Larry and Sergey would still have been quite rich, because they built a company that has produced enormous profits. As owners, they could have laid claim to a significant share of Google's net income (nearly $14.5 billion for 2014.) In order to benefit from that wealth, they would have had to decide how much of that net income to reinvest in the business to help its continued growth, and how much to take out for themselves and their employees in the form of wages or dividends. And they would have paid taxes on those wages or dividends.

As it turns out, the value that Larry, Sergey, and other early insiders have realized from Google through financial markets roughly matches the share of Google's profits they could have claimed as owners of a private company. But that isn't always the case. Some companies (including many startups) have stock market valuations far in excess of the actual profits that the companies generate. That's because financial markets have increasingly gone from being a source of capital for companies to a kind of giant betting pool, in which winning and losing is much less correlated with underlying economic activity.

This is a contributor to economic inequality that not enough people are talking about. In an economy where financial instruments are increasingly unmoored from the real market of goods and services and profits derived from those services, it's possible for many people to reap rewards that weren't actually earned. I'm not just talking about bubble-inflated stock-based compensation that has made many people in Silicon Valley so rich, or the excesses of Wall Street banks which nearly wrecked the economy in 2008, but the entire structure of executive compensation.

What Paul Graham Is Missing About Inequality
[Tim O'Reilly/Medium]

(via O'Reilly Radar)

(Image: Americans For Inequality, Donkey Hotey, CC-BY)