Growth or contraction? Depends on the data you use.

From How People Get Rich Now by Paul Graham.

Interesting and engaging at several levels.  There has been a longstanding concern in economic academia that the pace of innovation has declined in the US.  Not according to Graham. 

Every year since 1982, Forbes magazine has published a list of the richest Americans. If we compare the 100 richest people in 1982 to the 100 richest in 2020, we notice some big differences.

In 1982 the most common source of wealth was inheritance. Of the 100 richest people, 60 inherited from an ancestor. There were 10 du Pont heirs alone. By 2020 the number of heirs had been cut in half, accounting for only 27 of the biggest 100 fortunes.

Why would the percentage of heirs decrease? Not because inheritance taxes increased. In fact, they decreased significantly during this period. The reason the percentage of heirs has decreased is not that fewer people are inheriting great fortunes, but that more people are making them.

How are people making these new fortunes? Roughly 3/4 by starting companies and 1/4 by investing. Of the 73 new fortunes in 2020, 56 derive from founders' or early employees' equity (52 founders, 2 early employees, and 2 wives of founders), and 17 from managing investment funds.

There were no fund managers among the 100 richest Americans in 1982. Hedge funds and private equity firms existed in 1982, but none of their founders were rich enough yet to make it into the top 100. Two things changed: fund managers discovered new ways to generate high returns, and more investors were willing to trust them with their money. 

But the main source of new fortunes now is starting companies, and when you look at the data, you see big changes there too. People get richer from starting companies now than they did in 1982, because the companies do different things.

Why would academics be concerned and Graham not?  Because they are looking at different data sets.  Graham is looking at data for the very tip top of companies and fortunes.  From that perspective, there seems to be a lot of improvement.  In 1982, 60% of fortunes were inherited.  Now that sounds like social and economic sclerosis.  In 2020, only 27% of fortunes were inherited.  Sounds like a positive trend (a proposition which would have to be tested though.)

75% of new fortunes are being made through the establishment of new companies.  New (large) companies disrupt, which is usually good for keeping a market efficient.  It also means that the founders are likely more attuned to market demands than the inheritors of fortunes.  It doesn't mean that they will be more or less authoritarian (a personality trait) but it will mean that they are better informed which has to somewhat of a good thing.  And it also means that, having disrupted, there is the potential for using the regulatory state to built a rent-seeking model rather than continuing in an innovation model.

In 1982, there were two dominant sources of new wealth: oil and real estate. Of the 40 new fortunes in 1982, at least 24 were due primarily to oil or real estate. Now only a small number are: of the 73 new fortunes in 2020, 4 were due to real estate and only 2 to oil.

By 2020 the biggest source of new wealth was what are sometimes called "tech" companies. Of the 73 new fortunes, about 30 derive from such companies. These are particularly common among the richest of the rich: 8 of the top 10 fortunes in 2020 were new fortunes of this type.

[snip]

The tech companies behind the top 100 fortunes also form a well-differentiated group in the sense that they're all companies that venture capitalists would readily invest in, and the others mostly not. And there's a reason why: these are mostly companies that win by having better technology, rather than just a CEO who's really driven and good at making deals.

[snip]

People who don't look any deeper than the Gini coefficient look back on the world of 1982 as the good old days, because those who got rich then didn't get as rich. But if you dig into how they got rich, the old days don't look so good. In 1982, 84% of the richest 100 people got rich by inheritance, extracting natural resources, or doing real estate deals. Is that really better than a world in which the richest people get rich by starting tech companies?

Indeed, it doesn't take much reading of history to be skeptical of the good old days.  On most measures, the good old days were pretty wretched, though every age has its celebration.  The further back you go people were poorer, had fewer choices, had less access to education, live shorter and more brutal lives, were less likely to live in an environment where they helped determine the governance of their community, etc.

Graham points that either 2020 is the aberration of 1982.  He then introduces research from 1892 from the Herald Tribune suggesting 1892 and 2020 are more similar to one another than either are to 1982, suggesting that it is 1982 which is the aberration.  

An essay column worth reading in whole.  

But back to the base question, why does Graham find growth and improvement while economists are concerned about stagnation and decline?

This contrast in interpretations has been around for a good two or three decades.

I think it is because they are looking at two different data pools.  Graham is using the changes in the top fortune demographics as a leading indicator of how things are progressing.  There are reasons to consider that perhaps the top 100 fortunes are not sufficiently representative to be informative.  It is a valid criticism that does need to be addressed. 

However, academics usually use the total number of new business formed and discontinued in a year.  They are measuring something different.  

Whereas Graham is looking at the efficiency of conversion of productive ideas (45 years to reach one billion dollars in constant revenue versus 8 today), academics are looking at the life cycle of all new companies, not just the successful ones.

They are concerned about the declining absolute number of companies being formed today and the increasing number of failures.  Fair enough.  Looks like an economic decline.  How to reconcile that with Graham's observations.

I suspect at least two factors.  One is a long held suspicion that the number of new companies started is not an especially good metric.  There are vanity companies in there (wife of a wealthy man starts a gift shop), as well as ego companies.  We have been in a thirty year cycle of large corporations doing massive RIFs and buyouts, many of those buyouts being put in part to starting desperation companies with low prospects of success such as Business Coach LLC.  I am not sure all these are sufficient in number but I suspect they might be.

The second factor is alluded to by Graham.  Growth is occurring in different sectors due to demographic, regulatory and technology changes.  As an example, I am guessing that family owned restaurants are now a dramatically smaller share of the restaurant sector than they were in 1982, displaced by chains.  Chains have a relative high survival rate whereas family/individual owned restaurants have a much lower survival rate.  

Essentially, Graham is looking at the churn rate among the top fortunes and the news there seems reasonably positive.  Academics are looking at total business corporations across all sectors and in all sorts of conditions and seeing a different a more challenging picture.

I suspect that Graham has the more valuable insight but I remain marginally concerned whether there are some deep, long cycles at play here as well.  1870-1910 were the years not only of industrialization) an economic phase shift, but also the years of robber barons, etc.  1932-1965 were the years of federalizing problem solving and economic management and a consequent centralization of power and regulatory squeeze.  1965-1990 were the years of deregulation again.

Is there some set of deep levers pushing some cyclicality?  I am not sure.  I am pretty confident you can't step in the same river twice but am also reasonably confident you can step within the same river banks twice.  Cyclicality?  Probably, but I don't have a confident read on it yet.