We have been always subjected to some sporadic reporting about income disparities between Whites and some minorities, mainly the Blacks and the Latinos.  What is different about the most recent report is that it dealt with wealth disparity instead of income and wage gaps. Economists have been aware of the wealth gap for sometime. While the shift is welcome news, do not expect this to lead to a permanent shift, in economic policy, away from income generation to wealth accumulation.

Economic policy makers tend to concentrate on incomes policies as opposed to wealth generation because economic policy impact on income is more direct and simpler to explain that the effect on wealth. The latter tends to be influenced by institutional and individual behavior.  Clarifying definitions are important here.

Income and Wealth

The American Heritage Dictionary defines income as the “amount of money or its equivalent received during a period of time in exchange for labor services, from the sale of goods or property, or as a profit from financial investments.”  Most concept of income will be a garden variety of the above definition. Wealth, on the other hand, is not amenable to such simplicity in definition.  Wealth (or net worth) could be defined as the sum of assets (what one owns) minus the sum of liabilities (what one owes). Economists also define wealth as accumulated savings. For our purpose here, these definitions will suffice. 

The reported poverty figures that have been used for policy purposes have relied on the family income data. In the February 13, 2004 issue of the Federal Register HHS Poverty Guidelines for the United States are provided. In that issue, the income threshold for poverty definition is provided for various household sizes. Excepting for the works of the Nobel Laureate Amartya Sen, poverty has never been consistently defined in terms absence of documented wealth; it has always been done as absence of income. As a result of this orientation, economic policy has been geared toward the improvement of current income.

I do not want to leave the impression that income is not important.  To the contrary, it is. However, current income, while necessary is not sufficient for long term sustainability of spending power and accumulation of wealth.

Income and Wealth Link:  Saving

High current income and wealth are not the same, but they are related through individual and institutional behavior referred to as saving. Prior estimation suggests that the relationship is positive: the higher the income, the higher the saving. However, on the average, marginal saving rate remains the same as income rises. For the United States, this has been steady at 10% since the 1940s.  For the Blacks and the Latinos to increase their rates of wealth accumulation, they will have to save at a higher rate than the average. Income parity does not translate into wealth equality. In a 2000 working paper by Maury Gittleman of U.S. Department of Labor titled, “Racial Wealth Disparities: Is the Gap Closing?” a dire prognosis was made that “Even if one could achieve parity in incomes (and saving rates), the racial wealth gap … would take 72 years  … to close.”

Narrowing the gap will take a combination of macroeconomic policy and behavioral change and the micro level.

Microeconomics of wealth accumulation

The statistics on the racial wealth disparity are so confounding that one is sometimes at a loss where to start. Here are some insights from the work of Gittleman and CFA publication.

Item.     The median net worth of the White households is 11 times greater than Hispanics families, and 14 times greater than the African-American families.

Item.     Home ownership rate in white households is between 73% and 77%, but 475 among Blacks and Hispanic households.

Item.     Thirty-five percent of African-American indicated a “planning horizon” of next few months as opposed to 20 percent of all Americans according to the Consumer Federation of America (CFA).

Item.     Thirty-two percent of African-Americans say that they do not save as opposed to 23 percent of all Americans. This was reported by CFA.

The low rates of home ownership among minorities constitute a serious obstacle to wealth accumulation and equalization. This also cuts the beneficial link between home ownership and business formation, since home equity will often serve as a collateral for start up business loan.

Change in consumption pattern is an absolute necessity in any effort to close the wealth gap. The tendency to save out of additional income (or in economic parlance, the marginal propensity to save) must increase for Blacks and Hispanics, if the wealth gap is to close in the long term.  Exclusive reliance on incomes policy will not do the job.

Related to the change suggested above is the need to increase the planning for the minorities, from few months to years.  This will have a positive impact on saving. Closing the wealth gap also requires a re-examination of attitudes toward risk in minority communities. While it is unclear what causes some individuals to be risk takers and others not, some studies have suggested that the lack of wealth reduces risk taking behavior.

Education and Information: closing the gap

All things being equal, high school graduates will record more life time earnings than those who drop out. And college graduates will earn, on the average, more than high school graduates. In a study published in the Journal of Economic Perspective (Summer 1998), Professor Edward Wolff reported that in 1983, the 40 percent of the top one percent of the wealth holders were college graduates  Moral of the story: Blacks and Latinos youths should be encouraged to stay in school.  In the sophisticated economy of the United States, a high school drop out will start at the lowest job ladder. At that level, saving becomes an uphill task.

While in college, occupational choice is very important. The information on occupational trend is readily available and updated by the U.S. Department of Labor Statistics.  The website is http://stats.bls.gov/oco

African-American and Latino households will have to become more involved in equity markets than they currently do. This extends to business and entrepreneurial endeavors.  While the risks are higher, but so are the returns.  About three quarters of white families own their homes, but less than have of black families do own their own homes.  This is a significant source of wealth disparity.  The numbers are worse in ownership of businesses. This is not to be done without proper planning and understanding of the inherent risks. 

In conclusion, the macroeconomic policies that are geared toward incomes have been very helpful, and continue to be, but closing the wealth gap will require policies, which while not de-emphasizing the short term income generation, that will emphasize wealth accumulation.