Harvard economist Greg Mankiw argues in a New York Times editorial that inherited wealth is helpful to the economy. But even a brief look at the evidence shows his claims don't stack up.
Greg Mankiw — most famous for his widely used undergraduate economics textbook and for being an adviser to both George W. Bush and Mitt Romney — has made a name for himself in recent years as a defender of economic and social inequality. Last year he wrote a paper entitled "Defending the One Percent," arguing for the "just deserts" view — that what people earn is what they deserve, and therefore government should not actively try to reduce the gap between the incomes of the richest and poorest.
Now, I don't think this is completely incoherent. If you work hard and build a business or career, then you should be rewarded with the fruits of your labor. If government tries to make everyone equal, then incentives to work hard and succeed are hugely reduced, resulting in stagnation. We see this in the economic stagnation of collectivist countries like Cuba, Venezuela, and the Soviet Union.
But it's hard to deny that there is also a huge element of luck involved, in terms of both an individual's upbringing and genes, and their educational, social, and business opportunities. And there's also the contribution of public goods like the roads we all drive on, government research, and military and police protection.
But rather than acknowledging these realities, Mankiw's latest piece goes a step further in the other direction. Mankiw now says that your "just deserts" are not just what you earn for yourself, but also whatever inheritance you may receive. He writes:
Those who have earned extraordinary incomes naturally want to share their good fortune with their descendants. Those of us not lucky enough to be born into one of these families benefit as well, as their accumulation of capital raises our productivity, wages, and living standards. [The New York Times]
How do we all benefit? Mankiw argues that inherited wealth provides resources to finance investment:
When a family saves for future generations, it provides resources to finance capital investments, like the start-up of new businesses and the expansion of old ones. Greater capital, in turn, affects the earnings of both existing capital and workers. [The New York Times]
So, if inherited wealth is tied to stronger levels of investments and business startups, you'd expect to see higher rates of economic growth in periods when inherited wealth dominated the economy, right?
But that's the opposite of what the evidence suggests. The pre-industrial world, in which the economy was dominated by landed gentry, kings, princes and barons, etc. — who left their children their vast fortunes — exhibited far lower economic growth than the modern world, as Thomas Piketty's data shows.
Inherited wealth, far from being a spur for economic growth, appears to be more of an impediment to it. Why? In a low-growth economy dominated by wealthy heirs, incentives are totally stacked against innovation, technological progress, and risk-taking. Lose your hereditary fortune, and you and your descendants would likely face a very difficult climb back to wealth. So any incentives to fund high-risk, high-reward projects involving invention, experimentation, and science are outweighed by the incentives to play it safe: To stick with tried-and-tested but inefficient methods of production. The name of the game is wealth preservation.
And under an economy dominated by inherited wealth, even those who can successfully innovate do not have much of a market to sell products to. A market with a few wealthy lords and lots of penniless serfs isn't much of a market. That's why it took the end of the feudal society for the social and technological innovation necessary for the industrial revolution and the birth of modern society to occur.
In other words, inheritance is a horribly inefficient way to allocate resources. That's why we see studies like this one, which estimates that British inequality costs the country's economy $66 billion per year. And with a large (if faltering) welfare system to offset inequality, Britain is not even the best example, especially in comparison to historic references or what could lie ahead.
Of course, feudal society had a far more rigid class system than today's. If you were born a serf in feudal France, the chances of you becoming a nobleman were slim to none. But today's class system is only fluid by comparison — a mere 8 percent of American men rise from the bottom rung of the economy to the top.
The danger of entrenched intergenerational inequality is why inheritance must be taxed — not so much as to impoverish the descendants of the wealthy, but to create a level playing field where innovation and research can flourish, where there is opportunity for all, and where anyone who has good ideas and works hard can rise to the top.
Allowing wealth to concentrate over generations is nothing more than a road to serfdom, a path back to the low-growth, low-innovation, unfree world of the Middle Ages.