How the Rich Get Richer

IMF Blog, November 30, 2020

Source details

Analysis uses 12-years of tax records (2004-2015) from Norway.
Norway's wealth tax requires assets to be reported by employers, banks and other third parties, reducing errors from self-reporting.
The data make it possible to match parents with their children, enabling intergenerational analysis.

Wealthier people earn higher returns on their investments.
An individual in the 75th percentile of wealth distribution who invested $1 in 2004 would have yielded $1.50 by the end of 2015—a return of 50 percent.
A person in the top 0.1 percent would have yielded $2.40 on the same invested dollar—a return of 140 percent.
Moving from the 10th percentile to 90th percentile of wealth distribution increases the probability of making it to the top 1 percent by 1.2 percentage points compared to an average probability of 0.89 percent.
High returns both bring individuals to the top of the wealth scale and prevent them from leaving it.

Conventional explanation: richer individuals put more of their assets toward high risk investments, which can result in higher returns.
New finding: wealthy people often earn a higher return even on more conservative investments—evidence of pure “returns to scale” to wealth.
Possible reasons for higher risk-adjusted returns at given portfolio allocations:
- Access to exclusive investment opportunities.
- Access to better wealth managers.
- Greater financial sophistication.
- Better financial information.
- Entrepreneurial talent.
These characteristics make the returns to wealth persistent over time.
The research is the first to quantify this mechanism and show that it is likely to matter empirically.

Wealth has a high degree of intergenerational correlation.
Children of the richest are likely to be very rich, but are unlikely to get as high returns from this wealth as their parents did.
Implication: money is perfectly inheritable, but exceptional talent (which contributes to exceptionally high returns) is not necessarily transmitted across generations.

Source: IMF Blog — How the Rich Get Richer (Davide Malacrino, November 30, 2020).