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Professor Jamshid Damooei considers the positive and negative impacts of wealth accumulation on prosperity and economic growth in the United States.

The inequality of wealth has risen sharply over the past twenty years, prompting many discussions about the social and economic consequences. In this article Professor Jamshid Damooei of Californian Lutheran University explores some of the current issues. In addition to being the Chair of Economics, Professor Damooei is Director of the Centre for the Economics of Social Issues at the University and has been writing and lecturing on social issues from an economic perspective. He is particularly well known for his work on investing in children and has been observing the consequences of the rise in wealth inequality over the last two decades.

 

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One of the most insightful looks into the accumulation and distribution of wealth, and what it would entail for the 21st century, comes from Thomas Piketty, the author of the recent best seller, Capital in the Twenty First Century.[1] He argues that wealth has always been with us but its importance is increasing. He explains that with the likely scenario of slow economic growth, coupled with high returns on capital investment, wealth inequality will continue to rise and income growth will be suppressed. This has been shown to be the case so far this century and thought to be one of the causes of the rise of political populism over the last few years.  Since the owners of wealth are likely to save much of their income and pass it on to their heirs this creates a situation in which individuals’ living standards will be determined more by the bequests they receive than their talents, skills, and efforts. This could be seen as a negative consequence of wealth accumulation.

Standard theories of wealth accumulation put strong emphasis on saving across the life cycle. However, a number of studies over the last several decades indicate that intergenerational wealth transfer is responsible for a substantial portion of wealth holdings in the United States and many other developed countries. These studies show that between 45 to 80 percent of wealth in one generation is likely to come from the previous generation. This suggests that the creation of wealth in large proportion comes through its transfer from one generations to the next.[2] The question is: what good or harm such massive transfer may entail for a society as it goes forward?

To answer this question it is necessary to make sense of what brings prosperity to people in one generation. In addition, we must observe the development of their personal wellbeing through work compared with return on their inheritance.

Continuation of economic growth has its own challenges. First, the inevitable onset of diminishing rate of return on all factors of production (reaching their steady state in the US and in many of the Western European economies). Second, the need for curbing the addiction to growth in order to have sustainable life on our planet. The idea of prosperity without growth is upon us and it is likely to gain greater momentum and become an inevitable reality of our future.

Joe Brewer (2015) in the blog called ‘The Rules’ writes about this ‘growthless’ prosperity:

“Wealth created by transferring productive capacity from one group of people will correspondingly create poverty for any other group of people that become deprived of the productive capacity by the process. Any kind of economic growth in the real world will be subject to these constraints.”[3]

This is a radical departure from the status quo. Mainstream economists propose that the source of wealth is innovation and free enterprise, and entrepreneurs who create jobs and introduce new products and services into the market. The above two ideas might seem a world apart but they do have a common point of reference. With wealth, productive capacity from one generation is transferred to the next. With the transfer of wealth comes the ability of the new owners to be in the drivers’ seat and decide where the available resources should be allocated. There is also an additional argument that those with wealth may decide to withdraw from the labour market and use the return on their wealth in place of workforce participation for the income they need. This may in turn reduce the wealth gap and allow higher income to be made by non-wealth owners as they move into the positions which would have been occupied by the wealthy. The reality, however, is quite different, and we are witnessing much greater income and wealth gaps between people within countries as well as among the nations.

Most studies do not go so far as to suggest that higher wealth will definitely create a persistent higher income earning ability among those who inherit the wealth.  There is a strong possibility, however, that the greater wealth holders will help their heirs to become better educated, develop a different attitude towards risk, and have much better access to financing, which is essential for those with innovative ideas and entrepreneurial abilities.

Relative wealth mobility is more sclerotic than that for earnings but is greater among families with large wealth stocks. While scholars debate whether family wealth affects educational attainment, even those who argue for an effect find that differential access to college only modestly affects relative earnings mobility. Recent research suggests family wealth may have a greater impact on early childhood education. Bequest recipients are also more likely to pursue self-employment; they are more likely to own their home. The neighborhood in which a child grows up (which may be influenced by family wealth) appears to affect health outcomes.

However, it is clear that creation of wealth and its transfer to the next generation has far-reaching consequences on those who are able to transfer wealth to their heirs. As the size of this wealth increases – along with its unequal distribution – governments will increasingly focus on possible ways of re-distributing this wealth in order to meet the burgeoning social demands on government finances, especially at a time when many countries’ fiscal resources are already stretched.

But this redistribution of wealth can occur in several ways, and this is the task facing policy-makers across the globe. One is through the government’s creation of an estate tax. Another equally important vehicle is the allocation of wealth through charitable giving and philanthropy.

Historically, charitable giving has been an important part of income distribution in many countries, including the United States and Western Europe. Recent studies show that there is a clear cyclicality in the trend of charitable giving.  According to a recent study published in the Atlantic, about 61 percent of households reported giving to charity in 2000, with an average gift of about $2,600. As a proportion of income, that means that the average person gave away 3.7 percent of his or her earnings. Each year after 2000, charitable giving increased by one or two percentage points until 2008, when the recession started and contributions began drying up.[4] By 2012, many had experienced a partial recovery, yet the likelihood of giving to charity kept falling, declining by 6 percentage points compared to 2000 (after controlling for factors such as wealth and income). This provides evidence that forces stronger than individual circumstances drove the decline in giving, and it could be that uncertainty from the recession has had a lingering effect.

Looking deeper into the existing research does not provide strong evidence that we have experienced any lasting change in the behavior of Americans towards charitable giving. However, the recent development of lifetime giving, as advocated by some notable wealthy families, such as the Gates Foundation, may not yet be captured in the data. Whilst there is little doubt that the accumulation of wealth is necessary for a nation’s well-being, it is increasingly recognised that how this wealth is used is just as important. But how to manage this wealth remains an open and complex question.

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[1] Thomas Piketty, Capital in the Twenty First Century, Harvard University Press, 2015.

[2] See Kotlikoff and Summers (1981), Mulligan (1997), and Menchik (1979).

[3] Joe Brewer, “The Real Story of Wealth Creation”, The Rules Blog, Accessed February 5, 2018, http://blog.therules.org/the-real-story-of-wealth-creation/

[4] Alexia Fernandez Campbell “Why Are Americans Less Charitable Than They Used to Be?” The Atlantic, December, 2016, https://www.theatlantic.com/business/archive/2016/12/americans-donate-less-to-charity/511397/