Vol. 4 No. 4| Spring 2003

IN THIS ISSUE

Racial Bias in Hiring

Don't Blame the System

How Much are Nonexistent Earnings Worth?

Financial Education Starts at Home

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Financial Education Starts at Home

Understanding the Relationship Between Parent and Child Wealth


Research by Erik Hurst

The similar economic position of parents and children is partly determined by how well parents teach their children to save.


Wealthy parents tend to have wealthy children. What accounts for this similarity? Is it because wealthy parents invest in their children's education, give their children financial gifts, or pass on similar savings behavior?

Erik Hurst, an assistant professor at the University of Chicago Graduate School of Business, and Kerwin Kofi Charles of the University of Michigan address the complex issue of parent-child wealth in their new study, "The Correlation of Wealth Across Generations."

Hurst and Charles use survey data that track a wide range of parent-child pairs over 30 years. They find that standard measures of household wealth such as income, human capital, and ownership of particular assets show very similar results for parents and children. Much of this persistence in wealth comes from the high and low end of the income distribution: children of very low wealth or very high wealth parents rarely end up in a substantially different economic position.

However, there is still a considerable amount of economic mobility within this range, and children are not necessarily bound by their parents' lot in life.

What explains the similarity in parent-child wealth? Income and portfolio composition account for the majority of the connection. Hurst and Charles suggest that savings behavior, as measured by the tendency for parents and children to own similar assets, is also an important part of the explanation. Children's economic choices may be shaped by their parent's savings tendencies, either through direct learning or simply by being in the same environment.

After controlling for parent and child income, Hurst and Charles found that education, past financial gifts, and expected future bequests play relatively insignificant roles in determining the connection between parent-child wealth. The modest effect of education is particularly noteworthy because it is commonly assumed that wealthy parents beget wealthy children primarily by financing their schooling. The study argues that if the transmission of education is important in explaining the similarity in wealth across generations, it can be seen in the child's income.

"Education is not the only thing you can give your child," says Hurst. "Informal discussions about savings over the dinner table can also have an impact. While education is important for your career path, you could easily earn a high income and then spend it all on trips to Las Vegas."

Family Money

Hurst and Charles use data from the Panel Study of Income Dynamics, a national survey started in 1968 which tracks social and economic variables of a given family over time. For each year of the survey, households answer questions about their age, race, family composition and education levels, and provide detailed information about their labor market participation and income.

Children of the core sample respondents become part of the survey as they leave their parents' household and form their own. The authors look at families with children between ages 25 and 65 in the 1999 survey, and parents who were part of the survey in 1984, 1989, and 1999. In total, Hurst and Charles studied 1,491 parent-child pairs to compare the economic decisions of parents to the economic decisions of their children.
The authors measure parent-child wealth before the giving of bequests. By looking at the pre-bequest relationship, the authors can explore why parents and children have similar wealth for the majority of their lives.

After adjusting for age, the authors find an intergenerational wealth elasticity of 0.37, implying that parents whose wealth is 10 percent above average in the parents' generation have children whose wealth is 3.7 percent above average in the children's generation. An elasticity of 1 would mean that parental wealth was the sole determinant of child wealth. An elasticity of 0 would mean that parents have no effect on child wealth. An elasticity measure between 0 and 1 indicates how mobile a society is across generations.

"The probability of being like your parents is much greater than being dramatically different from them," says Hurst. "But there is still a fair amount of mobility in society depending on your perspective. It is a half full/half empty scenario with many exceptions to the rule."

More than one-third of parents in the lowest wealth quintile have children whose wealth places them in the three highest quintiles in the child group. Seven percent of children whose parents were in the lowest wealth quintile make it to the top quintile. Comparable to the low end of the distribution, 11 percent of the children of high wealth parents fall to the lowest quintile. However, it is also the case that almost 70 percent of high wealth parents have children whose wealth places them in the top two quintiles.

Learning to Save

Parents and children tend to generate very similar income flows during their lives, with income accounting for half of the connection between parent and child wealth. Wealth, though, is dependent not only on income, but how much of that is saved.

The authors employ a commonly used method to determine savings behavior-measuring household asset composition, and therefore preferences, as an indicator of household savings tendencies. They find the correlation between parent and child income also carries over to similar savings rates. Having a parent who owns stocks, a business, or a home makes a child much more likely to hold the same asset.

Thirty-six percent of the intergenerational wealth elasticity can be attributed to tendencies among parents and children to hold similar assets. This tendency is, apart from income, the next most important reason why wealth tends to be similar across generations.

In general, the fact that a parent owns an asset is enough to predict that the child will as well, most likely because of parental example. Parents and children may therefore have similar wealth because of similar tendencies to save out of any given income stream.

Links to Welfare

In documenting how children may learn from the savings behavior of their parents, the authors present evidence of an important social phenomenon-people respond to education about finances. This finding has larger policy implications for issues of welfare and inner city development, especially in regards to stimulating the savings of low-income households.

"If people can learn to save, the question for policymakers then becomes whether these findings can be turned into an actual policy program," says Hurst. "People need to learn how to manage the money they receive. Requiring financial literacy courses with the receipt of welfare payments may improve the long-term economic position of low-income households."

 

Erik Hurst is assistant professor of economics at the University of Chicago Graduate School of Business.

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