How the Rich Get Richer

Source: Adobe / Hyejin Kang

Davide Malacrino is an economist in the research department of IMF (IMF).

Wealth creates wealth. This simple concept of privilege has contributed to growing dissatisfaction with inequality that has escalated in the shadow of the COVID-19 pandemic.

ONE paper Co-authored this year by economists at the IMF and other institutions, affirms that wealthier people are more likely to get higher returns on their investments. It also shows that while the children of wealthy people are likely to inherit that wealth, they will not necessarily get the same high returns on investment.

Detailed data on wealth are extremely rare, but 12 years of tax records (2004-2015) from Norway opened a new window of wealth creation for individuals and their descendants. The Nordic country has a wealth tax which requires employers, banks and other third parties to report assets to avoid self-reporting errors. The data, which are published under certain conditions, also make it possible to match parents with their children.

The data shows that a person in the 75th percentile of wealth distribution who invested $ 1 in 2004 would have made $ 1.50 by the end of 2015 – a return of 50%. A person in the top 0.1% would have made $ 2.40 on the same dollar invested – a return of 140%.

Another key finding: high returns put individuals at the top of the wealth scale and prevent them from leaving. If you check age, parental background, and income, and move from the 10th percentile to the 90th percentile of the wealth distribution, the chance of getting below the top 1% increases by 1.2 percentage points versus an average probability of 0 , 89%.

How the rich get richer 102

Why do rich people earn high returns? Conventional evidence suggests that richer people invest more of their wealth in risky assets, which can lead to higher returns. However, our research has found that wealthy people, even with more conservative investments, often achieve higher returns. Richer people enjoy pure “economies of scale” for their wealth. Specifically with a given portfolio allocation, those with higher wealth are more likely to achieve higher risk-adjusted returns, possibly because they have access to exclusive investment opportunities or better asset managers. Financial sophistication, financial intelligence, and entrepreneurial talent are also important. These properties make the return to prosperity persistent over time. This research is the first to quantify this mechanism and shows that it is likely to have empirical relevance.

Will high returns persist over generations? The answer is a qualified yes. Wealth has a high degree of intergenerational correlation, but there are important differences in the ways in which returns on wealth are generated across generations. The children of the richest are likely to be very rich, but they are unlikely to get as high a return on that wealth as their parents. This suggests that while money is perfectly heritable, exceptional talent is not.
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