Social Mobility and the Great Gatsby Curve (GGC)

2/20/2017

Class Announcements

Syllabus Update

Review From Last Time

Rising U.S. inequality

Income vs. wealth inequality

Income inequality drives wealth inequality
- unequally distributed income gets saved and results in unequally distributed wealth
Trends/causes in income inequality similar to wealth inequality
- wealth inequality much harder to track/measure (e.g tax havens)
- wealth inequality much higher than income inequality
- that is, wealth concentrated among smaller number of households

Income Inequality

Although a global issue, income inequality is particularly important in the US in terms of both its level and in recent changes. Large advanced economies have seen a persistent trend of rising inequality for decades, as the very highest earners capture a larger share of aggregate income. Until the 1980s, the US experience was similar to other countries, as recently as 1975, the top 1% garnered a similar share of the income in the US as in other G7 countries, as shown in Figure 1. But since 1987 the share of income going to the top 1% in the US has exceeded every other G7 country in each year that data are available. Moreover, the US has continued to diverge further from other advanced economies, with the top 1% income share rising 0.2 percentage points a year on average in the US from 1990 to 2010, well above the 0.1 percentage point average increase in the UK, for example. While comparable international data are scarce after 2010, the gains of the top 1% have continued in the US. In 2014, the top 1% captured 18% of income, up from 8% in 1975 (World Wealth and Income Database 2015).

Wealth Inequality

One perspective on wealth inequality comes from the Federal Reserve’s Survey of Consumer Finances which, as shown in Figure 2, shows that the top 3% of households have held more than 50% of aggregate wealth since 2007 (Bricker et al. 2014). This share has been on a consistent uptrend since the late 1980s. The next 7% of households in the wealth distribution hold roughly 25% of aggregate wealth, a share that been fairly stable time during this period. Notably, the loss in wealth share experienced by the bottom 90% of households, which in 2013 held only 25% of all wealth, is accounted for by the rise in share captured by the top 3%. This is not a uniform spreading of the wealth distribution, it is a rising concentration of wealth at the very top. Another perspective on wealth, from imputed numbers based on tax data on capital income, finds an even larger increase in wealth concentrated at the very top of the distribution (Saez and Zucman forthcoming).

Quiz Question Example

Typically, income inequality is _____ concentrated than wealth inequality.

(a). more

(b). less

(c). about the same

(d). they are not comparable

(e). none of the above

Quiz Question Answer

Typically, income inequality is _____ concentrated than wealth inequality.

(a). more

(b). less

(c). about the same

(d). they are not comparable

(e). none of the above

Roadmap from Today

Social/Economic Mobility
Relationship between inequality in opportunity and income inequality
- The Great Gatsby Curve

Visualizing Economic mobility

Death of the American Dream?

Image8. Poverty is back up because wages at the bottom have stagnated or fallen. Over the past 40 years, workers in the bottom 40 percent of the wage spectrum experienced negligible wage growth, and wages have fallen for those in the bottom 10 percent, after accounting for inflation. The trends have been worse for men than women, in no small part because women’s increased educational attainment and on-the-job experience have boosted their wages over the past few decades. Researchers find that the lack of wage-and-income growth for families at the bottom of the income ladder in particular results in serious economic consequences. First, the continued lack of income growth harms low-income children’s development, which affects our nation’s future human capital. Second, a growing body of evidence suggests that the lack of income gains at the bottom have macroeconomic consequences because it either reduces consumption or encourages more debt, both of which are destabilizing.

Social/Economic Mobility

Social Mobility
- Ability to obtain better employment opportunities (syn. rise in the social hierarchy)
- Generational: Work at McDonald as a teenager, but is a teacher at 30 years old
- Intergenerational: Father is a janitor, daughter is an investment banker
Economic Mobility
- Ability to earn higher income (syn. move up the economic latter of success)
- Generational: Earn $5/hr as a teenager, but earn $20/hr at 30 years old
- Intergenerational: Father lifetime earnings is $100,000, daughter lifetime earnings is $400,000
Social/economic mobility used interchangeably, but focus today on intergenerational economic mobility

Inequality of Opportunities: Three forms

Disadvantages faced by children in low-income families
- e.g. access to quality education
Inequities in the criminal justice system
Challenges women face in the US economy

The ‘Great Gatsby’ curve (GGC)

Coined by former Council of Economic Advisers Chairman Alan Krueger (Princeton Economist)
Shows relationship between income inequality and intergenerational mobility
- more income inequality related to less mobility for children from low-income families

Main Idea straightforward - greater income inequality in one generation amplifies the importance of family background (e.g income) for the economic status of the next generation.

The ‘Great Gatsby’ curve, a term introduced by former Council of Economic Advisers Chairman Alan Krueger, illustrates the relationship between income inequality and inequality of opportunity. Figure 3 shows that areas of the US with more income inequality also tend to have less mobility for children from low-income families. A similar pattern holds across countries. The Great Gatsby curve shows that inequality is correlated with lower mobility, and one important transmission mechanism is the distribution of opportunity. When disparities in education, training, social connection, and the criminal justice system are distributed as unequally as overall wealth, poorer families have a much harder time succeeding in the economy.

The idea is straightforward: greater income inequality in one generation amplifies the consequences of having rich or poor parents for the economic status of the next generation.

Overwhelming supporting evidence (within and across countries)

Why is it called The Great Gatsby

Cynical term relating to the illusion of the American dream
- "Rather than a celebration of such decadence, the novel functions as a cautionary tale in which an unhappy fate is inevitable for the poor and striving individual, and the rich are allowed to continue without penalty their careless treatment of others' lives."

Empirical Evidence of the GGC

Cross-Country (Corak, 2013 - Required Reading)
U.S. ( Chetty et al. )
China (Fan, 2015 - Required Reading)

Corak, 2013 - Required Reading

Background

Countries with more income inequality…
- family background play a stronger role in determining children future economic success
- children own hard work less important role.
- e.g. good for kids from rich families, but bad for everyone else
Rising income inequality stifles upward social mobility
- makes it harder for talented and hard-working people to obtain rewards from their work
Want to study relationship between income inequality and economic mobility across generations

Empirical Set-up

"Intergenerational earnings elasticity" is derived from a regression-to-the mean model

\[ln Y_{i,t} = \alpha + \beta ln Y_{i,t-1} + \epsilon_i\]

Y is permanent earnings for individuals from particular family $i$ across two generations, $t$ and $t-1$.
- usually limited to father-son earnings, avoids changing role of women in labor force
$\beta$ important parameter of interest, “intergenerational earnings elasticity"
- degree to which earnings are "sticky" across generations within the same family
- Higher/significant $\beta$: Father's place in earnings distribution important predictor of Son's adult earnings
- Lower/insignificant $\beta$: Father's place in earnings distribution does not determine Son's adult earnings/place on the earnings ladder
$\epsilon$ error term (captures other influences on child's adult earnings)
$\alpha$ constant term captures trend in average incomes across generations (e.g changes in technology)

Cross-Country GGC

x-axis: Gini Coefficient
- Sweden, Finland Low Gini
y-axis: intergenerational earnings elasticity
- Denmark, Norway Low elasticity
Relationship BTW Income inequality and mobility
- More unequal countries are Less mobile

The figure ranks countries along two dimensions. The horizontal axis shows income inequality in a country as measured by the Gini coeffifi cient from about a generation ago. During the early to mid 1980s, Finland, Sweden, Norway, and Denmark were the most equal; the United Kingdom and the United States, the least. The vertical axis is a measure of intergenerational economic mobility: specififi - cally, the elasticity between paternal earnings and a son’s adult earnings using data on a cohort of children born, roughly speaking, during the early to mid 1960s and measuring adult outcomes in the mid to late 1990s. In countries like Finland, Norway, and Denmark, the tie between parental economic status and the adult earnings of children is weakest: less than one-fifi fth of any economic advantage or disadvantage that a father may have had in his time is passed on to a son in adulthood. In Italy, the United Kingdom, and the United States, roughly 50 percent of any advantage or disadvantage is passed on.

Comparing U.S. and Canada

U.S. intergenerational earnings elasticity ($\beta$): .5 Canada intergenerational earnings elasticity ($\beta$): .25

Differences in mobility driven by differences in the extremes of parents' earnings distribution (top and bottom 10%)
- 50% of Sons in U.S. raised by fathers in top decile (10%) remain in top 3 deciles
- 40% of Sons in U.S. raised by fathers in bottom decile (10%) remain in bottom 2 deciles
- See Figures 2 and 3 next

It turns out that the American intergenerational earnings elasticity, at about 0.5, is twice as high as the Canadian, and this has little to do with the degree of mobility of children raised by families in broad swaths of the middle part of the distribution. Indeed, a comparison of the full decile transition matrices reveals a good deal of mobility in both countries, to the point that there is little relationship between family background and child outcomes (Corak and Heisz 1999; Mazumder 2005). It is at the extremes of the distribution that the two countries differ, as illustrated in Figures 2 and 3. In the United States, sons raised by top and bottom decile fathers are more likely to occupy the same position as their fathers than they are in Canada. More than half of sons raised by top decile American fathers fall no further than the 8th decile, and about half of those raised by bottom decile fathers rise no further than the third decile. In Canada, there is less stickiness at the top, and a much higher proportion of bottom decile sons also rise to the top half of the earnings distribution.

Explaining GGC: Mechanism I

Uneven Returns to education/skill training

The earnings premium: average employment income in 2009 of men 25-34 with college degree versus average income of their counterparts with only high school diploma
Higher return to college education, less intergenerational mobility
some outliers though (e.g. Italy)

relates the intergenerational earnings elasticity to the earnings premium a college graduate has over a high school graduate. The earnings premium is measured as the average employment income in 2009 of men 25 to 34 years of age with a college degree relative to the average income of their counterparts with a high school diploma (OECD 2011b, table A8.1). return to college education is higher, intergenerational mobility tends to be lower. Clearly, this is a tendency, and there are notable outliers—particularly Italy and to a degree also Finland—suggesting that other forces dominate in those countries. But the premium is higher in the United States than any other country included in the fifi gure: a college graduate earns about 70 percent more than a high school graduate, compared to about 30 percent in Canada.

Explaining GGC: Mechanism II

Uneven enrichment expenditures on children

Expenditures refer to investments outside formal schooling
- e.g. books, computers, child care, summer camps, private schooling, etc.
higher investments help promote a child’s human capital in early years
- increases skills/aptitudes,
- higher success in admittance to top colleges

Explaining GGC: Mechanism III

Uneven social/business networks

Children in families from top decile much more likely to work in the same firm as parent

Great Gatsby Curve in the U.S.

Gap between rich and poor

U.S. Economic Mobility

Child born into bottom quintile has 33.7% chance of remaining there as an adult
Chile born into top quintile has 36.7% chance of remaining there as an adult

Put another way…

Ranking of child vs parent income

Map of Mobility

Model Regression Results

Negative and statistically significant effect of Gini coefficients on absolute and relative mobility
Cities with higher inequality exhibit lower levels of mobility

Notes: Each column reports regression coefficients from an OLS regression with all variables normalized to have mean 0 and standard deviation 1 in the estimation sample, so univariate regression coefficients are equal to correlation coefficients. Columns 1-5 are estimated using data for the 709 CZs with at least 250 children in the core sample. The dependent variable in Columns 1-4 is our baseline CZ-level measure of absolute upward mobility, the expected rank of children whose parents are at the 25th national percentile in the core sample. In Column 5, the dependent variable is relative mobility, the rank-rank slope within each CZ. In Column 3, we restrict to CZs that intersect MSAs. In Columns 1-5, the Gini coefficient is defined as the Gini coefficient of family income for parents in the core sample in each CZ; the top 1% income share is defined as the fraction of total parent family income in each CZ accruing to the richest 1% of parents in that CZ; the Gini Bottom 99% is defined as the Gini coefficient minus the top 1% income share; and the fraction between p25 and p75 is the fraction of parents in each CZ whose family income is between the 25th and 75th percentile of the national distribution of parent family income for those in the core sample. In Columns 6-8, the dependent variable is the log-log IGE estimate by country from Corak (2013, Figure 1). The Gini coefficients across countries are obtained from the OECD Income Distribution Database (series "Income Distribution and Poverty: by country"). We interpret these coefficients as applying to the bottom 99% because the surveys on which they are based are typically topcoded. The top 1% income share across countries is from the World Top Income Database (series "Top 1% Income Share"). The independent variables are measured in 1985 in Columns 6 and 7 and in 2005 in Column 8.

U.S. commuting zones were ordered by Gini coefficient and divided into 20 equally sized bin

Note: U.S. commuting zones were ordered by Gini coefficient and divided into 20 equally sized bins. Each blue dot represents a single bin. Upward mobility reflects the mean percentile in the 2011-2012 national income distribution for those individuals in each bin whose parents were at the 25th percentile of the national income distribution between 1996 and 2000. Source: CEA calculations based on Chetty (2014).

data finds that areas within the U.S. that have greater income inequality also tend to have less upward mobility for children from low-income families (see graph below). They further find that young children who move to areas with substantial upward mobility tend to reap the benefit of living in those surroundings, suggesting that changes to environmental factors can enhance economic opportunity.

Although time-series evidence on trends in intergenerational income mobility has been mixed, in part because those born after the great burst in income inequality in the 1980s still have relatively little labor market experience, it is clear that the dramatic rise in inequality in the U.S. since the late 1970s has not been accompanied by a decline in the correlation between parental rank in the income distribution and their children’s eventual rank in the income distribution. These facts imply that the incomes earned by those born in the bottom half of the income distribution are falling further behind the incomes of those born to parents in the top of the income distribution, on average. As Chetty and coauthors observe, “[T]he consequences of the ‘birth lottery’ —the parents to whom a child is born — are larger today than in the past.”

Explanatory Drivers of the GGC

High mobility areas characterized by
- less residential segregation
- less income inequality
Also, better primary schools and greater family stability

Figure 2, which is based on research by Sean Reardon (chapter 5), shows the academic achievement gap between children from rich and poor families. Between 1978 and 2008, the gap between the average mathematics test scores of children from highand low-income families grew by a third (from 96 points on an SAT-type scale to 131 points in 2008). Given the importance of cognitive skills in determining educational success, it should come as no surprise that this growing test score gap has translated into a growing gap in completed schooling.

These growing gaps in educational attainment have translated into less educational mobility, particularly for men. Until about 1970, fewer than one in ten young adult men and women had completed less schooling than their parents. By the 1990s, more than 20 percent of men and almost as large a fraction of women had less education than their parents. Since education has been the dominant pathway to upward socio-economic mobility in the United States, the growing gap in educational attainment between children from rich and poor families is likely to result in increased income inequality in future generations and hinder the intergenerational socio-economic mobility that has been a source of pride for Americans.

Positive Gains The living situation of the American poor is better today than it was half a century ago. Fifty years ago, President Lyndon Johnson declared a war on poverty and ushered in the most extensive support system for the poor in history, and in 2010 President Barack Obama stitched the final major thread into that safety net with the passage of the Affordable Care Act (ACA). Medicaid has ensured that those in poverty could get some measure of health care. Public housing and vouchers have made it so most had a roof over their heads. We’ve raised the minimum wage 22 times since its inception and instituted at least 126 different anti-poverty programs.1 Because of programs like SNAP, rent subsidies, and refundable credits like the EITC, overall purchasing power rose for those in the bottom quintile from 1973 to 2012, even while actual cash income fell.2 If you include tax credits, cash, and in-kind benefits in the calculations, the poverty rate has actually fallen from 26% in 1967 to 15% in 2012, as Jason Furman, the President’s Chairman of the Council of Economic Advisors recently noted.3 In all, we have spent nearly $15 trillion on anti-poverty programs since 1964; and in 2012 alone, the federal government spent more than $668 billion.4

Likewise, some of the grinding non-economic barriers to success have been worn down, though not erased. Discrimination based on race, ethnicity, gender, disability, and sexual orientation has begun to diminish over time. In 1980, not one Fortune 100 company had a woman in a top-tier executive position; today all but 17 do.5 Then there were only 22 African-American or Hispanic legislators in Congress; today there are 81—as well as the President of the United States.6 The Americans with Disabilities Act opened public and private accommodations to the disabled. And we are making steady progress on equality for gay and transgender people in the home and in the workplace.

Though there has been improvement for many groups who have historically faced hurdles in our country, one vexing problem remains the same: a child born at the bottom of the income ladder today is no more likely to move up than 50 years ago. This child is unlikely to ever make it to the top—or even to move up a few rungs. Our mobility problem is concentrated almost entirely among those in the lowest economic quintile and runs counter to our ideal of how American society should operate. According to basic mathematic principles, there will always be a bottom quintile—but what we as a society cannot tolerate is the existence of one that is impermeable.

OTher mechanisms to explain Other mechanisms could also underlie the Great Gatsby Curve. For example, if social connections are important for success in the economy (e.g., getting the right summer internship), and wealthy parents have access to job networks, then a spreading out of the income distribution would leave children from the bottom of the distribution in a more disadvantaged position in terms of gaining access to networks that will ultimately lead to a higher paid job.

A note about Inequality of Opportunities vs. Income inequality

Debate about relationship between income (wealth) inequality and growth
- Recall Week 2 Lecture
- some income inequality good (economic competition rests on idea that competition for unequally distributed rewards entourages production)
- limit inequality, reduce growth opportunities
Relationship between opportunities inequality and growth much simpler
- when inequality so entrenched that limits opportunity, narrows pool of human capital that can compete
- limiting future competition can reduce growth by reducing dynamism in labor markets and reduce firm entry
- high inequality of opportunity bad for equity and efficiency

The traditional argument that inequality results from normal economic competition rests on the notion that competition for unequally distributed rewards encourages production. But when inequality has become so entrenched that it passes across generations and limits opportunity, it narrows the pool of human capital that can compete. Such throttling of opportunity is bad for growth, preventing potential innovators and workers from full economic participation and weighing on productivity growth. Further, if entrenched interests are able to limit future competition either by influencing the policymaking process or by abusing their market power, dynamism in labour markets or firm entry can decrease. The implications of unevenly distributed opportunity are simpler than those of income and wealth inequality — working the wrong way for both equity and efficiency.

These three forms of inequality discussed above are not conceptually distinct phenomena — they closely affect one another. Wealth inequality is, in some respects, an outcome of income inequality, as the saving of unequally distributed income produces unequally distributed wealth. But inequality of opportunity is in many ways both a cause and a result of income and wealth inequality. Therefore, unequally distributed opportunities entrench an unequal income distribution, and an unequal income distribution leads to many of the inequities faced by low-income and low-wealth children.

Next Time

China inequality and the social mobility
- China (Fan, 2015 - Required Reading)

Group Discussions

Economist Article
News articles on U.S/China inequality

Questions

Is social mobility a zero-sum game? That is, in order for poorer individuals to move up the economic ladder, richer individuals need to move down. Do you agree? yes or no?
Adults that inherit wealth from parents often times need to pay taxes (inheritance tax). How is inheritance tax related to economic mobility? Do you think that inheritance should be taxed?