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How to reduce the vast black-white wealth gap

A pile of money.

A pile of money. Credit: iStock

A very interesting report on the racial wealth gap just came out. A team of researchers led by economists William Darity Jr. and Darrick Hamilton set out to illustrate the scale of the problem, and to debunk certain myths surrounding the issue. Their results are sobering, but also offer important insight into how the problem might be addressed.

The racial wealth disparity between white and black Americans is stark and persistent. Some portion can be explained by differences in education, homeownership and employment, but the authors show that even controlling for these factors, the gap is huge.

Even if black people earn a college or advanced degree, get a full-time job and own a home, they’re likely to have far fewer assets than their white counterparts.

The authors also address a second trope -- the idea that black Americans are less wealthy because they’re less frugal. Musician Kanye West might have been tongue-in-cheek when he sang, “You know, white people get money, don’t spend it/ Or maybe they get money, buy a business,” but there’s little question that the stereotype has permeated popular culture. And white savings rates are indeed higher. The problem, as Darity et al. show, is that the only reason white Americans save more money than their black counterparts is that they earn more in the first place.

Basic economic theory says that rich people should save more of their money than poor people. If you’re a senior executive or wealthy entrepreneur making say $15 million a year, you can splurge on private jets and mansions, but ultimately you run out of things to buy -- so, instead, you save. But if you’re scraping by on $15,000 a year, every dollar you save comes at the expense of something essential -- food, rent, clothing, heat or payments on the car used to get to work. Since white Americans, on average, earn more than black Americans, we’d expect them to have higher savings rates even without being more frugal.QuickTake Income Inequality

How much of the savings gap is due to income is an empirical question, and the statistical methods differ. Papers do exist that assert that most of the difference is due to frugality, but these are in the minority. Economists Robert Barsky, John Bound, Kerwin Charles and Joseph Lupton found that two-thirds of the savings gap could be explained by income, and Maury Gittleman and Edward Wolff found that income explained all of the difference. So for black people, saving more in order to close the racial wealth differential would impose a severe economic burden.

If savings, education, employment and homeownership won’t close the racial wealth divide, what will? On Twitter, University of Chicago sociologist Eve Ewing gave her answer: “WE NEED REPARATIONS.”

The idea of giving black Americans reparations for the past injustices of slavery, segregation, redlining, and other discriminatory policies isn’t a new one. There are many moral arguments for and against reparations, and I won’t rehash them here. But there’s little question that reparations could be used to close the black-white wealth gap.

In a separate paper, Darity and Hamilton suggest a different way to close the wealth gap. They suggest giving children so-called baby bonds, paid for out of tax revenue. Each child eligible for the policy would get some amount -- say, $20,000 -- in government bonds. If the policy were used as a form of reparations, it would be a one-shot affair, given to black Americans, but if -- as Hamilton has suggested -- it were used to replace current welfare programs, it could be a permanent, ongoing benefit given to all poor children. Either way, it’s a bold idea with much to recommend it.

But there’s at least one potential problem with the idea of using baby bonds -- or, indeed, any form of lump-sum reparations -- to close the racial wealth gap. Returns on bonds, one of the safest assets, don’t match the returns on riskier assets like stocks or real estate. This may already figure in the black-white wealth gap. Though Gittleman and Wolff found no difference in rates of return for whites and blacks, economist Mariela Dal Borgo in a recent paper did find that white people earn considerably higher returns.

That could be due to black Americans putting less of their money in real estate, possibly out of fear of predatory lending, housing discrimination, or local governments doing things that reduce the value of black homes. It could also be due to black Americans putting less in stocks, perhaps because they’re shut out of the human networks of financial advisers and planners that coax investors into the market.

An answer to this could be to give black children, instead of baby bonds, shares in a social wealth fund. This would be a fund, or collection of funds, run by the government and investing in a broad array of financial assets -- stocks, real estate investment trusts, etc. -- much like the sovereign wealth funds of resource-exporting nations. Although this would certainly expose black Americans to market risk -- which is necessary to make a good return over the long term -- the fund would manage their money alongside the money of many white citizens, ensuring that discrimination wouldn’t allow black assets to wither.

As of now, these ideas seem like a remote political possibility. But as time goes on, as wealth inequality increases, and as the racial wealth gap remains wide, they may start to look like viable options.

Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.