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Why do wealthy parents have wealthy kids?

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A National Bureau of Economic Research (NBER) working paper sought to answer this question: What determines whether children of wealthy parents will be wealthy themselves? That is, is the transmission of wealth genetic or environmental?

It turns out that even when you factor out any bequests, the transmission of wealth is environmental. The researchers who wrote the working paper used data on adopted children in Sweden, which tracks the net worth of all its citizens, along with their adoptive and biological parents, to determine the correlation between wealth and family. The researchers measured net wealth by subtracting total debts from total wealth.

(Joe Pinsker first reported on this study in The Atlantic. You can attempt to download the paper itself for free here at NBER’s website, though you may have to pay for it. And if you want to quote it, you must include the copyright notice, as I do here: © 2015 by Sandra E. Black, Paul J. Devereux, Petter Lundborg, and Kaveh Majlesi).

In Poor Little Rich Kids? The Determinants of the Intergenerational Transmission of Wealth, the academics from Texas, Sweden and Ireland conclude the children of rich parents become wealthy, too, not “primarily because children from wealthier families are inherently more talented or more able but that, even in relatively egalitarian Sweden, wealth begets wealth.”

This “substantial role for environment and a much smaller role for genetics” remains the case “even prior to any inheritance,” the researchers report.

The case mentions the rising rates of income and wealth inequality in the developed world, particularly in the U.S., and cites French economist Thomas Piketty’s  2013 book Capital in the 21st Century  that helped bring the issue to the forefront, since his work “highlights the intergenerational transmission of wealth as a key determinant of the nature of society more generally.”

Since they’re economics researchers, the authors mention in passing some important points that an advisor might find interesting:

1. Wealth is probably a better measure of economic success than income or education. 

2. Wealth is more easily transferred across generations.

3. Wealth is much less equally distributed than education and income.

The researchers explore previous studies that looked at whether the correlation of higher wealth among succeeding generations came from the “genetic inheritance of skills, attitudes and preferences.”

Why should you care whether it’s nature or nurture? One reason would be to understand your current clients and whether their children are more likely to be wealthy in their own right. Another, the researchers point out, has to do with governmental policies that seek to raise revenue while not placing an undue burden on the wealthy or limiting children’s future success. They write, for example, that “a tax on parental wealth is likely to have less implication for intergenerational mobility if the intergenerational wealth correlation is predominantly due to nature rather than nurture.” There has been research showing a genetic component to levels of risk-taking behavior, and the Swedish adoption data has been used in at least one research paper looking at risk taking in the financial markets. Those studies, the researchers say, found that characteristics  of both biological and adoptive parents were predictive of child outcomes.

First, here’s a brief report on how the study was conducted. The researchers used data on the net wealth of adopted children in Sweden born between 1950 and 1970 and compared it with data for their biological and adoptive parents and those adoptive parents’ biological children, all using Sweden’s wealth registry for the data. The adoption dates are important because in those years, private adoptions were illegal in Sweden, so the government handled all adoptions and thus has the data; the adoptions were also conducted randomly.

The researchers admit that “wealth” in Sweden differs in some ways from the U.S., such as in its retirement system and its family law. But they make other points that they say allow the data to be applied to other countries, including the U.S. For example, stock market participation rates are higher in Sweden than in many other countries, including the U.S., and in Swedish divorce law there is no incentive for one parent to hold on to more assets.

Reasons for nurture over nature

So if the data clearly shows that nurture begets wealth rather than nature, why is that the case?

The researchers admit that wealthier parents tend to be better educated and have higher incomes, so maybe their children’s wealth comes from those better educated parents “teaching them about investment opportunities or providing the right opportunities.” No, the data doesn’t support that argument.

So maybe wealthier parents invest more in their children’s education and career? That doesn’t work either, according to the data.

What the researchers posit is that answer may be that children of wealthier parents “may choose to save more or invest in assets that have higher returns,” or be more likely to make “financial gifts from parents to children.” They conclude that “Unfortunately, we do not have information on savings behavior or on financial gifts so this evidence is only suggestive,” though they did find that “innate childhood abilities do not drive the intergenerational correlations in wealth.”