The wastrel child effect


in Economics, Geek stuff, Politics, Rants

Talking with Lauren the other day, it occurred to me that the strongest force redistributing wealth across human history has quite possibly not been progressive taxation of income or estate taxes. Rather, it may be the tendency of the children of the wealthy and powerful to be hopeless wastrels. One generation builds up a gigantic fortune and the next one (or two, or three) disperses it again with some combination of bad decisions and lavish living.

It seems plausible to say that really gigantic fortunes only build up when some new factor unbalances the existing economic system. For instance, companies realize that it will only be possible to train staff in the use of one computer operating system. In the process, Microsoft and Bill Gates make colossal fortunes. Similar explanations can be used when it comes to railroad barons, the current wealth of Gulf oil states, and so on.

The people who build up these fortunes probably always need a combination of talent and good luck. They need to have the giant fortune opportunity in the first place, and then they need to act effectively to realize it. The sort of people who are able to do that are probably pretty unusual, for the most part. By contrast, their offspring are more likely to be normal in traits like intelligence (regression to the mean). It is also entirely possible that they will live seriously distorted lives, as the result of parental success. This is as true of the heir to a major fortune or family business as it is to the heir to a particularly successful hereditary monarch. Once in a while, they may be able to build on the success of their predecessor. More often – I would wager – they either start or perpetuate the decline of that success.

All told, it is probably an extremely good thing that the children of people like Elizabeth I or Bill Gates don’t generally rise to the level of success of their parents. Given how limited most states are – when it comes to putting checks on income inequality – it seems plausible to me that a world with a high probability of hereditary success would probably be one ruled by powerful families reminiscent of the Middle Ages. The fact that there is at least the occasional mad or incompetent person who ends up in a position to squander the family’s wealth and influence is probably a significant reason why we don’t all live like peasants, ruled over by feudal lords.

If it hasn’t already been done, somebody should undertake a statistical analysis of the relative financial success of the children of highly wealthy individuals. It could cover as long a span as we have good records for (which would vary by country) and would help to establish the significance of this hypothesized wastrel effect. As I said, I would not personally be surprised if the total economic effect has been redistribution on a greater scale than that achieved by taxation.

{ 13 comments… read them below or add one }

R.K. December 17, 2010 at 5:19 pm

A.K.A. the Paris Hilton effect

Matt December 17, 2010 at 10:24 pm

Paris Hilton is almost certainly a net positive earner. Although we like to think of her as being useless, she has a lot of money making power.

As for Bill Gates’ children, it’s virtually impossible to be more successful than the most successful person in all of history. That’s not to say there’s a guarantee they won’t be successful by most standards in their own right.

I’m just curious if you have any examples of the children who have squandered their inheritance. I’m sure there are lots of examples, but it doesn’t seem like it’s necessarily universal.

For instance, companies realize that it will only be possible to train staff in the use of one computer operating system. In the process, Microsoft and Bill Gates make colossal fortunes.

At least according to Triumph of the Nerds, that’s not really at all how Microsoft came to dominance. It was more Bill Gates’ extraordinary business skills, his foresight and, after a while, his ability to leverage the fortunes Microsoft had amassed to make even more.

Milan December 18, 2010 at 12:35 am

Yeah, some actual data would be preferable to pure speculation on my part.

oleh December 19, 2010 at 12:19 pm

This is an interesting theory. Such a study could be interesting.

I would also be interested in the effect on the next generation in other ways and in particular on the incentive to work when the wealth of the previous generation does not require that you do so.

Even on a smaller scale, I observe that the difficulty of the next generation in affluent families who feel a sense of entitlement. So one struggle for parent in an affluent family is to consider what extras to provide to their children because the affluence makes it possible) and what to withhold (so that the child does not develop an unrealistic expectation of the ease with which such extra’s are acquired.

I am reminded of Jimmy Pattison among the wealthiest people in British Columbia. This wealth was acquired through his own business acumen. I understand that he decided not to leave his great fortune to his children perhaps for fear of those children developing wastrel quality you write about. He has been quite philanthropic in donating money , even before it become as popular as it has with the Gates and Buffets of the world.

Milan December 19, 2010 at 8:14 pm

If it is real, the Wastrel Child Effect could be an important counter to the Matthew Effect.

. April 20, 2011 at 8:11 pm

But when the subject turned to succession, the responses were much less rosy. Only 58 per cent said they were confident their children would be able to properly manage the money left to them, according to the survey, which will be made public Tuesday.

The number was low but it didn’t necessarily come as a shock to Andrew Auerbach, head of BMO Harris Private Banking. When he talks with clients about transferring wealth from one generation to the next, concerns about how the next generation will manage its money are always at the forefront.

“It’s not so much doubting the capabilities of the children, it’s simply that they haven’t really thought in a deep way as to what that will look like,” Mr. Auerbach says.

But effective wealth management means more than resisting the urge to spend the family inheritance. A proper strategy ensures the estate is invested soundly so that it will grow, rather than be consumed over time.

As baby boomers prepare for the largest transfer of wealth the modern banking sector has ever seen, ensuring that children don’t blow their inheritances is a growing concern, particularly on the heels of the economic downturn.

. June 7, 2011 at 5:42 pm

SIR – In response to a letter from America, from James Roby Day (May 7th), on the future of the British monarchy, another federation and democracy—Australia—is still struggling with its constitutional evolution, and is coming to different conclusions from Mr Day’s romantic monarchism.

Australia has deep affection and respect for the queen, and is unlikely to cut its ties while she reigns. But isn’t it modern practice to retire at the usual age, or is a constitutional monarch as immutable as the pope? The weakness of the monarchy lies in the lottery of the first-born: think of “The King’s Speech” example and contrast that with more disposable heads of state.

“And what about the Commonwealth?” you say. When heads of former colonies, mostly republicans, meet the queen it is usually for nostalgic, insignificant purposes. But wait, Mr Day, the concept of Commonwealth is good—it’s been our title for more than a century and, as with other dominions, our de facto head of state is honourably called the governor-general. It is entirely appropriate to remember a great, no-nonsense Englishman, the Lord Protector Cromwell, instituted the Commonwealth of Great Britain long before the French or American revolutions, and he showed us a model without that Greco-Roman name of republic.

Colin Lendon
Acton, Australia

. October 27, 2014 at 10:59 pm

More important, I believe Piketty’s r > g analysis doesn’t account for powerful forces that counteract the accumulation of wealth from one generation to the next. I fully agree that we don’t want to live in an aristocratic society in which already-wealthy families get richer simply by sitting on their laurels and collecting what Piketty calls “rentier income”—that is, the returns people earn when they let others use their money, land, or other property. But I don’t think America is anything close to that.

Take a look at the Forbes 400 list of the wealthiest Americans. About half the people on the list are entrepreneurs whose companies did very well (thanks to hard work as well as a lot of luck). Contrary to Piketty’s rentier hypothesis, I don’t see anyone on the list whose ancestors bought a great parcel of land in 1780 and have been accumulating family wealth by collecting rents ever since. In America, that old money is long gone—through instability, inflation, taxes, philanthropy, and spending.

You can see one wealth-decaying dynamic in the history of successful industries. In the early part of the 20th century, Henry Ford and a small number of other entrepreneurs did very well in the automobile industry. They owned a huge amount of the stock of car companies that achieved a scale advantage and massive profitability. These successful entrepreneurs were the outliers. Far more people—including many rentiers who invested their family wealth in the auto industry—saw their investments go bust in the period from 1910 to 1940, when the American auto industry shrank from 224 manufacturers down to 21. So instead of a transfer of wealth toward rentiers and other passive investors, you often get the opposite. I have seen the same phenomenon at work in technology and other fields.

. February 23, 2017 at 6:54 pm
. February 24, 2017 at 12:15 am
. August 25, 2017 at 8:33 pm

The offspring of Africa’s strongmen are living it up

Scions of despots post pictures of their lavish lifestyles on social media

. December 14, 2017 at 6:35 pm

The positive argument for steep inheritance taxes is that they promote fairness and equality. Heirs have rarely done anything to deserve the money that comes their way. Liberals, from John Stuart Mill to Theodore Roosevelt, thought that needed correcting. Roosevelt, who warned that letting huge fortunes pass across generations was “of great and genuine detriment to the community at large”, would doubtless be aghast at the situation today. Annual flows of inheritance in France have tripled as a proportion of GDP since the 1950s. Half of Europe’s billionaires have inherited their wealth, and their number seems to be rising.

. December 14, 2017 at 6:36 pm

Ordinary people were receptive to these arguments, perhaps because Americans are an optimistic bunch. According to Messrs Graetz and Shapiro, surveys at the time suggested that around 40% believed that they were in the top 1% of the wealthy or would be there “soon”, making them fearful of a hefty tax. The prospect of repeal was popular, even if in reality most of the benefits would go to the richest.

Yet keeping things in the family has costs. By excluding family firms from inheritance tax, and therefore stopping some from breaking up, means boosting their numbers. A paper by Francisco Pérez-González of the Instituto Tecnológico Autónomo de México finds that “nepotism hurts [firm] performance by limiting the scope of labour-market competition”. Firms that promote family CEOs see declines of 14% in operating return on assets, a measure of profitability. Research by Nick Bloom of Stanford University and others finds that family firms are the worst-managed of any type. Poor management of firms is one of the main reasons why productivity growth in rich countries has been so depressed in recent years.

If the importance of inheritance continues to grow, and Mr Piketty’s calculations suggest that it will, some worry that it could foreshadow the return of an inheritance society in which marriage ends up being a surer route to riches than starting a company or working hard. The incomes attained by the top 1% of French inheritors are already higher than those attained by the top 1% of workers. Across North America, Europe and East Asia, the number of billionaires who have inherited their wealth seems to be rising, according to research from the Peterson Institute for International Economics, a think-tank.

Leave a Comment

Previous post:

Next post: