Researchers simulated the performance of a large number of investors who started out with equal amounts of capital and who realized returns annually over a number of years. [Image courtesy Tracy O ]
New model isolates the effects of chance in an investment-based economy Media Note: Embargoed until 4 p.m. CT Thursday, July 21. For a copy of the study, e-mail jfalk [a] umn (p) edu. MINNEAPOLIS / ST. PAUL (07/21/2011) —Most of our society’s wealth is invested in businesses or other ventures that may or may not pan out. Thus, chance plays a role in where the wealth of a society will end up.
But does chance favor the concentration of wealth in the hands of a few, or does it tend to level the playing field’ Three University of Minnesota researchers have built a simplified model that isolates the effects of chance and found that it consistently pushes wealth into the hands of a few, ever-richer people.
The study, “Entrepreneurs, chance, and the deterministic concentration of wealth,” is published in the July 20 issue of the journal PLoS ONE.
The researchers simulated the performance of a large number of investors who started out with equal amounts of capital and who realized returns annually over a number of years. But wealth did not remain equal, because each year an entrepreneur’s return was a random draw taken from a pool of possible return rates. Thus, a high return did not guarantee continuing high returns, nor did early low returns mean continuing bad luck.
Even though all investors had an equal chance of success, the simulations consistently resulted in dramatic concentration of wealth over time. The reason: With compounding capital returns, some individuals will have a string of high returns and, given enough time, will accumulate an overwhelming share of the wealth.
This appears to be a fundamental feature of economies where wealth is primarily generated from returns on investment (for example, through business ownership and growth), the researchers said.
“Predictions from this model about how wealth is distributed were more accurate than predictions from classic economic models,” said first author Joseph Fargione, an adjunct professor of ecology, evolution and behavior in the university’s College of Biological Sciences.
The model predicts that the rate at which wealth concentrates depends on the variation among individual return rates. For example, when variation is high, it would take only 100 years for the top 1 percent to increase their share of total wealth from 40 percent—a recent level in the United States—to 90 percent.
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