What is wealth and how does it work?
What is it, where does it come from, and why do some have more than others?
If you wanted to get rich, how would you do it?
This is the question that Paul Graham poses at the start of his essay, How to Make Wealth. And what does Paul Graham suggest as the answer?
I think your best bet would be to start or join a startup.
Not a surprising take from someone who has benefited from building a startup, and more importantly, having it pay off. However, as he points out, there is nothing all that new about startups.
The name may be new, but the concept is essentially the same as venture-backed trading voyages of the Middle Ages.
In other words…
A startup is a small company that takes on a hard technical problem.
The essay goes on to cover why startups are so effective in wealth creation. They certainly aren’t a sure bet, but they are a reasonable bet if you have the stomach for it.
Imagine this scenario, for instance.
You’re presented with two bets. Option A, $1,000,000 with 95% chance of success or Option B, $10,000,000 with 20% chance of success. Which do you choose?
Most of us would choose the $1,000,000 option. We recognize that a high probability of, what still amounts to a large sum of money, is a very good proposition. Sure, we could make 10X as much, but our risk of loss increases significantly!
But what does the expected payout suggest?
Option A = $950,000 ($1 mil * 95%)
Option B = $2 mil ($10 mil * 20%)
As you can see, even if we move Option A to 100% probability, it will still be only half the expected payout of Option B.
This is the difference between those who go into startups (or similar high-risk high reward ventures) and those who take the “sure” bet. It is the difference between working 3 years with the goal of making $10 mil at the end vs working 30 years with the goal of $1 mil. Neither is certain, but one is certainly more likely than the other.
So what does this tell us about wealth creation? Before answering that, let’s first go through 3 questions that will help us better understand wealth.
1. What is wealth?
Wealth is not the same thing as money. Wealth is as old as human history. Far older, in fact; ants have wealth. Money is a comparatively recent invention.
Wealth is the fundamental thing. Wealth is stuff we want: food, clothes, houses, cars, gadgets, travel to interesting places, and so on. You can have wealth without having money.
Wealth is what you want, not money
Money is merely the mechanism we have invented to move wealth. It is a representation of wealth. It is a way for us to indirectly trade our wealth with others.
Wealth can be thought of in a similar way to Maslow’s hierarchy of needs.
![Maslow's Hierarchy of Needs | Simply Psychology Maslow's Hierarchy of Needs | Simply Psychology](https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fbucketeer-e05bbc84-baa3-437e-9518-adb32be77984.s3.amazonaws.com%2Fpublic%2Fimages%2F0b8a9b4e-e51f-46b8-8983-8408e000ea70_2000x1052.jpeg)
Each one of these levels represents a different aspect on what people want. The bottom two are so important they are even labeled needs. The “things” that make up this hierarchy are the same “things” that makeup wealth.
Accordingly, those most effective at providing solutions to these “wants/needs” are the ones with the greatest wealth. There is a caveat to this, but we touch on that in question 3.
2. Where does wealth come from?
The people most likely to grasp that wealth can be created are the ones who are good at making things, the craftsmen. Their hand-made objects become store-bought ones. But with the rise of industrialization there are fewer and fewer craftsmen.
People think that what a business does is make money. But money is just the intermediate stage-- just a shorthand-- for whatever people want. What most businesses really do is make wealth. They do something people want.
A coder can bang out some code and create wealth. An artist can birth a new painting and create wealth. A contractor can build a house and create wealth.
Most people view wealth as a fixed pie. Paul refers to this as The Pie Fallacy, and describes it simply as, “if one person gets more, another has to get less.” However, this is not how wealth works.
Let me give an example from one of my son’s books, Joseph Had a Little Overcoat.
Joseph starts off with an overcoat, but it gets old and worn, so he turns it into a jacket. The jacket gets old and worn, so he turns it into a vest. So on and so forth until he has a button, which he eventually loses. Now Joseph has nothing… so then he writes a book about it, “which proves,” says the book, “that you can always make something out of nothing.”
The real trick to creating wealth, as Paul points out, is…
You just have to do something people want.
3. Why do some have more wealth than others?
If wealth means what people want, companies that move things also create wealth. Ditto for many other kinds of companies that don't make anything physical. Nearly all companies exist to do something people want.
In a company, the work you do is averaged together with a lot of other people's. You may not even be aware you're doing something people want. Your contribution may be indirect.
This brings us back to that bet I proposed earlier. The one where most of us choose the “sure” bet and mitigate our losses. We choose to average our efforts, and therefore we average our wealth.
Don’t get me wrong, I think for most people taking the “sure” bet makes sense.
Especially when it comes to finding a job. Does it make sense for most people to risk their longterm livelihood on a high risk, high reward payoff? Certainly not. Most people are better suited to find a job, either at a startup or a larger company.
But Paul wants us to make sure we understand what happens when we make that choice.
As he said in the quote above, “In a company, the work you do is averaged together.” It is really difficult for a company to assign individual values to every person. This leads to predictable salaries for predictable work.
However, it also removes the possibility of being an above-average (or even extraordinary) employee of that business.
If you want to go faster, (make more money and/or build more wealth) it's a problem to have your work tangled together with a large number of other people's.
The one’s who are most effective at accumulating wealth are the ones in high leverage positions who also have highly measurable results tied to their work.
Before moving on…
Above we asked three questions:
What is wealth?
Where does wealth come from?
Why do some have more wealth than others?
Those answers can be summed up as such:
Wealth is what you want - the hierarchy of needs.
Craftsman/businesses who provide something people want (physical or not)
Those who get rich do so by getting into a high leverage position that has measurable results.
Increasing Measurement and Leverage
Smallness = Measurement
When the company is small, you are thereby fairly close to measuring the contributions of individual employees. A viable startup might only have ten employees, which puts you within a factor of ten of measuring individual effort.
Here is one reason why Paul suggests people join startups. They are smaller by nature, which allows an individual to get much closer to receiving the actual wealth they are creating. Even with an averaging effect this is the case. For instance, would you rather average yourself with 100 people or 10?
Paul provides an example to clarify.
A big company is like a giant galley driven by a thousand rowers. Two things keep the speed of the galley down. One is that individual rowers don't see any result from working harder. The other is that, in a group of a thousand people, the average rower is likely to be pretty average.
If you took ten people at random out of the big galley and put them in a boat by themselves, they could probably go faster. They would have both carrot and stick to motivate them.But the real advantage of the ten-man boat shows when you take the ten best rowers out of the big galley and put them in a boat together.
In other words, if you combine your labor with 999 other individuals, your wealth is likely to be pretty average. If, instead, you worked with 9 other individuals, your wealth is likely to be very different than the average. (This means either well above or well below.)
So if your goal is to increase your ability to measure the results of your labor, it is best to get into a small group with your peers and work your butt off.
Technology = Leverage
What is technology? It's technique. It's the way we all do things. And when you discover a new way to do things, its value is multiplied by all the people who use it.
This is nothing new. We’ve been growing our technology as a species for thousands of years. It doesn’t even have to be a gadget, as most people might think when hearing the word technology.
For instance, McDonald’s got as big as it did by developing a new system of management - creating a uniform service no matter the location.
What is tricky about this portion of growing wealth, is that timing new technology can be very difficult. Sometimes a new technique/gadget comes about just a few years too early.
However, this is beneficial to small groups.
Suppose you are a little, nimble guy being chased by a big, fat, bully. You open a door and find yourself in a staircase. Do you go up or down?
I say up. The bully can probably run downstairs as fast as you can. Going upstairs his bulk will be more of a disadvantage. Running upstairs is hard for you but even harder for him.
If the goal is to increase leverage (developing new tech) it is best to be in a small group. You can run upstairs and chase after those hard problems. At that point, the big bully isn’t your competitor, it is other small nimble guys.
What’s the catch?
If it were simply a matter of working harder than an ordinary employee and getting paid proportionately, it would obviously be a good deal to start a startup.
So in practice the deal is not that you're 30 times as productive and get paid 30 times as much. It is that you're 30 times as productive, and get paid between zero and a thousand times as much.
This is just like choosing Option B in the initial scenario. Some fortunate individuals get the win, while most are left with nothing to show for their efforts.
Wealth can be created, and individuals can get paid handsomely for effectively delivering what people want. However, most individuals can also go bust in this pursuit.
This can then become a source of great contention within society. Those who take big risks can earn big rewards. Those who play it safe, most likely receive an average reward. And when the pie grows, yet the average reward stagnates or shrinks, we can be left feeling like we have a broken system.
And in large part, I’d agree. The system is not ideal. It may be one of the best the world has ever seen, but still not ideal.
It doesn’t help that wealth is a complicated thing. In particular, giving every person the wealth they deserve is not easy. Especially in a society where most people’s efforts are averaged together.
But as we think about how to better shape society, to better share the rewards, we must first understand what it is we are actually trying to divvy up.
Wealth. What people want.