A substantial chunk of their essay is a review and critique of the arguments in Thomas Piketty's 2013 book Capital in the Twenty-First Century. I assume that even readers of this blog, who are perhaps more predisposed than normal humans to find such a discussion of interest, have mostly had enough of that. For those who want more, some useful starting points are my post on "Piketty and Wealth Inquality" (February 23, 2015) and on "Digging into Capital and Labor Income Shares" (March 20, 2015).
Here, I want to focus instead on the empirical evidence Arnott, Bernstein, and Wu about dynastic wealth in the United States. They focus on evidence from the Forbes 400 list of the wealthiest Americans, which has been published since 1982. They look both at how many famous fortunes of the earlier part of the 20th century survived to be on this list, and at the evolution of who is on this list over time. They write:
Take, as a counterexample, the Vanderbilt family. When the family converged for a reunion at Vanderbilt University in 1973, not one millionaire could be found among the 120 heirs and heiresses in attendance. So much for the descendants of Cornelius Vanderbilt, the richest man in the world less than a century before. ... The wealthiest man in the world in 1918 was John David Rockefeller, with an estimated net worth of $1.35 billion. This was a whopping 2 percent of the U.S. GDP of $70 billion at that time, nearly two million times our per capita GDP, at a time when the nation was the most prosperous in the world. An equivalent share of U.S. GDP today would translate into a fortune of over $300 billion. ... The Rockefellers ... scored 13 seats on the 1982 Forbes debut list, with collective wealth of $7 billion in inflation-adjusted 2014 dollars. As of 2014, only one Rockefeller (David Rockefeller, who turned 100 in June 2015) remains, with a net worth of about $3 billion.If dynastic wealth accumulation were a valid phenomenon, we would expect little change in the composition of the Forbes roster from year to year. Instead, we find huge turnover in the names on the list: only 34 names on the inaugural 1982 list remain on the 2014 list ...
Arnott, Bernstein, and Wu offer a number of ways in which dynastic wealth is eroded from one generation to the next: 1) low returns (including when the rich "fall prey to knaves); 2) investment expenses paid to "bank trust companies, `wealth management' experts, estate attorneys, and the like"; 3) income, capital gains, and estate taxes; 4) charitable giving; 5) when fortunes are divided among heirs; and 6) spending, as in when some heirs do a lot of it. Their overall finding based on the patterns in their data is that among the hyper-wealthy, the common pattern is for real net worth to be cut in half every 14 years or so, and for it to decline by about 70% from one generation to the next.
If the inequality of wealth is not a dynastic phenomenon and dynastic wealth in fact tends to fade with time, then why has inequality of wealth remained high in recent decades. Arnott, Bernstein, and Wu suggest two alternatives.
One is the huge run-up in asset values in recent decades, including the stock market. However, the authors make an important and intriguing point about these valuations. From a long-run viewpoint, gains from stock market investment need to be connected to the profits earned by companies. In the last few decades, a major change in US stock market is that dividends paid by firms have dropped. In In the past, those who owned stock looked less wealthy right now, but because of owning stock they could often expect to receive a hefty stream of dividend payments in the future. Now, those who own stock look more wealthy right now (after the run-up in stock prices), but they appear likely to receive a lower stream of dividend payments in the future. Thus, more of the future profit performance of a company is showing up in the current price of the stock, and less as a payment of dividends in the future. This is a more complex phenomenon than a simple rise in wealth inequality.
The other change that they point to are the enormous payments being received by corporate executives, often through stock option. The authors are writing in a publication of the libertarian Cato Institute. Thus, it is no surprise when they write: "We have no qualms about paying entrepreneurial rewards (i.e., vast compensation) to executives who create substantial wealth for their shareholders or
who facilitate path-breaking innovations and entrepreneurial growth." But then they go on to add:
But an abundance of research shows little correlation between executive compensation and shareholder wealth creation (let alone societal wealth creation). Nine-figure compensation packages are so routine they only draw notice when the recipients simultaneously run their companies into the ground, as was the case with Enron, Global Crossing, Lehman Brothers, Tyco, and myriad others. It’s difficult for an entrepreneur to become a billionaire, in share wealth, while running a failing business. How can even mediocre corporate executives take so much of the pie? Bertrand and Mullainathan (2001) cleverly disentangled skill from luck by examining situations in which earnings changes could be reasonably ascribed to luck (say, a fortuitous change in commodity prices or exchange rates). They found that, on average, CEOs were rewarded just as much for “lucky” earnings as for “skillful” earnings. The authors postulate what they term the “skimming” hypothesis: “When the firm is doing well, shareholders are less likely to notice a large pay package.” A governance linkage is also evident: The smaller the board, the more insiders on it, and the longer tenured the CEO, the more flagrant “pay for luck” becomes, while the presence of large shareholders on the board serves to inhibit skimming. Perhaps shareholders should be more attentive to governance?
