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Getting to the Bottom of Rising Wealth Inequality

May 17, 2017

Portrait of Simone Civale underneath a pine tree

Portrait of Simone Civale underneath a pine tree
Photo by Matthew Weber, CLAgency

Economics PhD candidate Simone Civale arrived at the University of Minnesota from Italy six years ago with his master's in econometrics in hand. Once at Minnesota, a program that consistently ranks as one of the top graduate programs in the country, Simone decided to pursue the field the school is best known for—macroeconomics. Out of the many pressing macroeconomic issues economists in the department are tackling, Simone took an interest in wealth inequality—an intriguing and much-debated subject, especially in the United States.

Labor and capital are the two factors that create income, and capital amounts to roughly thirty percent of all inputs in production. In the United States, one-third of the capital is in the hands of the richest one percent. Labor, on the other hand, is not nearly as concentrated. "That's one motivation for economists to study wealth inequality," says Simone. "The other motivating fact is that wealth inequality has increased substantially in the last 30 years." In addition, it is not a phenomenon that economists can accurately quantify, as there are several alternate methods of measurement and different methods reveal different increases.

"It would be ideal if the government had reliable data, but unfortunately, we do not have that in the United States," explains Simone. "Americans do not file taxes on their wealth, they file taxes on their income." Due to the lack of reliable government data, economists are forced to find other sources. In his job market paper, Civale references the Survey of Consumer Finance for data on wealth, pairing the trends he observes with another macroeconomic phenomenon. "I study a mechanism that has contributed to increasing wealth inequality, which is driven by another macroeconomic trend—the decline in the price of investment goods relative to consumption goods."

Simone explains that over the last 50 years, technological progress has made the production of investment goods (such as machinery, software, and equipment used in the production of goods) cheaper than the production of consumption goods (such as apparel, food, and household appliances), thus creating a decline in the relative price of investment goods. “In my model, I build on something that has been studied in the literature as being a cause of wealth inequality—entrepreneurship.” In terms of entrepreneurial activity, some entrepreneurs run more successful businesses with higher returns on their investment than others. “This is key to understanding why as the price of investment declines, this asymmetrically hits producers with different levels of productivity,” Simone said, emphasizing one of the driving forces of the rise in wealth inequality, that the declining price of investment negatively affects less productive entrepreneurs more severely than entrepreneurs with higher productivity.

After using a model to simulate how the United States' economy reacts to a decline in the relative price of investment goods, Simone found that, along several different measures of wealth inequality, the mechanism he studies captures half of the increase in wealth inequality. The implications of these findings are vast, and include future predictions about wealth inequality. "Wealth inequality speaks to society's perception of what is equitable," emphasizes Simone. "Furthermore, income and wealth concentration have an impact on economic growth."

Writing this working paper reinforced Simone's notion that studying wealth inequality is of high importance, and that the work in the field is far from complete. "There are lots of contributions to be made in the field, and lots of room for empirical contributions," says Simone. "We have a good understanding of what might be causing and increasing wealth inequality, but we need more data to rule out the wrong theories and rule in the right ones." Simone is currently working on research that observes entrepreneurship in publicly traded firms with the goal of understanding to what extent returns to entrepreneurial activity are heterogeneous.

"Empirical contributions are where we need to put a lot of effort," said Simone, when discussing what is next on the horizon for wealth inequality research and policy implications. Additionally, more comprehensive data would augment the quality and effectiveness of this research. With empirical contributions and more reliable data, the work surrounding wealth inequality in the future is bound to expand and improve, allowing us to understand the causes and consequences of increasing wealth inequality.

This story was written by an undergraduate student account executive in CLAgency. Meet the team.