May 2001

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Is the Distribution of Wealth a Problem?

by Chris Sarlo

The older I get, the more I am inclined to agree with David Foot’s maxim that "demographics explains two-thirds of everything." Whether it is strictly two-thirds, or is in fact some other percentage is not crucial. If we are trying to explain some socio-economic phenomenon or trend, demographics is a good place to start.

Let’s take the distribution of income as an example. Economics has a well-known "life cycle" hypothesis. It states, roughly, that people’s incomes rise as they move from young adulthood to mature adults. Our peak earning years, on average, are when we are in our 50s. After that, our incomes usually decline due to such factors as health problems, early retirement, and structural unemployment. However, people’s spending patterns are different, typically, than their incomes. Consumption is smoother and more stable than income. People apparently gear their spending to a kind of lifetime average income rather than their current income. There is abundant empirical evidence supporting this particular hypothesis.

So, when we see that roughly 40 percent of all income flows to the top 20 percent (the top quintile) of households (and only about 4 percent to the bottom 20 percent (the bottom quintile) of households, we are not entirely surprised. Age is the dominant factor explaining this outcome. The folks in the top income quintile are largely in their prime earning years. Those in the bottom quintile are usually a lot younger and, in many cases, are not yet established in careers. To be sure, there are educational and skill differences that help explain income disparities. Also, there are a small number of super-rich people (sports, entertainment, and business high performers) who tend to stretch out the income distribution. But age, by far, is the biggest factor. People who are in the bottom quintile in their 20s will most likely find themselves in the top quintile in their 50s.

With wealth (net worth), we would expect the distribution to be even more unequal, again, because of age. Young people have not had an opportunity to accumulate much wealth. Indeed, if they are or have been post-secondary students, their wealth is likely to be negative. They will frequently have student loans, an auto loan, and possibly loans to buy furniture. Their assets, comparatively, will be quite modest. Yet their situation will typically improve dramatically over time. When they are their parents’ ages, they will be in the top wealth bracket. Again, this is not to dismiss such factors as family type, occupational differences, and the super rich. However, age, by far, is the major consideration.

A little simulation exercise is illustrative. Imagine a society that is completely egalitarian in the sense that everyone has identical lifetime incomes. However, everyone has different incomes at different stages of their lives. People in this society would start at an entry level wage and move up the income ladder with experience in their jobs. If every single member of society went through this lifetime pattern, we would end up with significant income disparities at any point in time. Specifically, the bottom 20 percent would receive about 7 percent of the income, and the top 20 percent, about 35 percent of the income. The wealth differentials would be even greater, as we might expect. For example, assume that everyone saves 8 percent of their income each year and purchases assets (including homes) that yield a real rate of return of 3 percent per annum. In this case, at any point in time, the bottom quintile (invariably younger people who simply haven’t had enough time to accumulate much wealth) would have less than 1 percent of the wealth, whereas the top quintile would have 47 percent. This is a large disparity, but it is based entirely on age differences. And this is in an entirely egalitarian society!

It is easy to extend such an illustration to better capture real differences in human behaviour. If we simply vary savings rates among the population (with some at 8 percent, some at 4 percent and some unable to save at all, until they reach age 40), we get even greater wealth disparities. In this case, the bottom 20 percent of society owns no wealth, while the top 20 percent owns more than 57 percent. Here, sharp differences in net worth are due solely to age and differential savings rates. Again, this illustration excludes additional wealth differences that might be due to different occupations and skills.

The recent release of Statistics Canada’s Survey of Financial Security is notable less for what it reveals about the distribution of wealth in Canada than for the popular reaction to it. The survey found that, in 1999, the bottom 20 percent of Canadian households had zero net worth while the top 20 percent had about 70 percent. Statscan also revealed that the median net worth of those in the top net worth quintile was 39 percent higher than the median net worth of those in the same quintile in 1984, whereas, for bottom net worth quintile households, there was no change in median net worth over the 15 year interval.

The Toronto Star, Canada’s highest circulation daily, views this information as "disturbing." However, anyone who understands how wealth is accumulated and the roles that age and personal savings rates play would not be surprised or disturbed by the results of this new survey.

First, the folks in the bottom net worth quintile in 1999 are not the same people as those in the bottom net worth quintile in 1984. Between 1984 and 1999, baby boomers entered their prime earning years. This is the richest group of 40- to 55-year-olds we have ever had. And there are many more of them than ever before. We should expect, on demographic trends alone, the net worth of the top quintile to grow even faster in the near future. But what about the bottom quintile? It would be surprising if the bottom quintile, as a group, ever had any net worth. They are young and often have debts! They have not been in the labour force long enough to have achieved any substantial wealth accumulation. As well, many of them are not thinking about accumulating wealth at this stage in their lives. This is hardly "disturbing."

Chris Sarlo teaches economics at Nipissing University in North Bay, ON. He is the author of Poverty in Canada, published by The Fraser Institute.