The return of Horatio Alger

Paul Krugman published a December article in The Nation called “The Death of Horatio Alger.” He argued “America actually is more of a caste society than we like to think. And the caste lines have lately become a lot more rigid.”

Recent research by Kerwin Kofi Charles and Erik Hurst looks at intergenerational mobility in more detail. Here is a brief summary of the article, and here is a pdf of an earlier version of the paper.

The published version, “The Correlation of Wealth Across Generations,” in the December 2003 Journal of Political Economy, tells us the following:

1. “Age-adjusted parental wealth, by itself, explains less than 10 percent of the variation in age-adjusted child wealth.”

2. 20 percent of parents in the lowest quintile of the parent’s wealth distribution have children who end up in the top two quintiles of their generation. One-quarter of the parents in the highest wealth quintile end up with kids in the two lowest quintiles.

3. The age-adjusted intergenerational wealth elasticity is 0.37. What does this mean? If parents have wealth 50 percent over the mean in their generation, the wealth of their children will be 18 percent above the mean in the childrens’ generation.

4. Income levels account for about one-half of the parent-child wealth relationship. In other words, high income parents tend to produce high income children, to some extent. The children earn much of their wealth. Education and financial gifts account for very little of the correlation across parents and children.

5. Parents and children allocate their financial portfolios similarly, whether for reasons of genes or learned behavior. These common patterns of investment and savings are the second biggest factor behind the intergenerational wealth correlations we observe.

Note that the figures above do not include income from bequests. In this regard they underestimate some of the intergenerational correlation. On the other hand, large numbers of individuals do not receive bequests until they are at least in the 50s, so the figures measure the opportunities open to them in the earlier stages of their lives. And note that the data are recent, the wealth of the children is measured in 1999.

So what is the bottom line? Yes, there is some correlation in wealth across the generations. But most of that correlation (almost seventy percent) comes from continued hard work and savings. The authors do not examine Krugman’s claim that mobility once was greater, but it seems premature to suggest that the American dream is gone.

Addendum: Cardinalcollective.com offers some useful discussion and links, here is Daniel Drezner’s treatment, again replete with links.