Answer by Jitesh Daga:
Not a word, but four –
THE GREAT GATSBY EFFECT/CURVE
Miles Corak, a Canadian economist, made the connection between income inequality and social mobility, and established that as income inequalities grew, the opportunities for upward social progression were reduced. The rich got richer whilst the rest struggled to stay on the ladder. Alan Krueger, at one time the chairman of the US president's council of economic advisors, had termed this connection "the Great Gatsby curve".
The Great Gatsby Curve was introduced in a speech in 2012 by Alan Krueger, Chairman of the Council of Economic Advisors. The Great Gatsby Curve illustrates the connection between accumulation of wealth in the previous generation and the ability of those in the next generation to move up the economic ladder compared to the previous generation.
The curve shows that children from poor families are less likely to improve their economic status as adults in countries where income inequality was higher. It signifies that wealth was concentrated in fewer hands around the time those children were growing up.
The Great Gatsby Curve shows that high income inequality prevents economic mobility while a lower level of income inequality activates mobility. Those aspiring to “spread the wealth round” immediately embraced the curve. After all, if income inequality is the only obstacle to upward mobility, they can simply redistribute wealth all the way to prosperity. But there is a big dispute about whether the apparent relationship between income inequality and mobility reflects actual “causes and effect.”
This paper contains references from U.S. because most of the previous research studies and work have been in context with U.S. policies.
What is The Great Gatsby Curve?
On the horizontal axis is the country’s Gini coefficient, the most commonly used measure of inequality (zero represents perfect equality among a country’s citizens, and 1 means, roughly, that one person gets all the money in a society). On the vertical is what labor economists call inter-generational earnings elasticity, or IGE — roughly a measure of how likely it is that if you’re rich (or poor), your kids will be, too. In a society with perfect equality of opportunity, the child of rich parents would have neither a higher nor a lower income than the average, yielding an IGE of zero.)
“The Great Gatsby Curve” graph plotted using data from Corak (2011), OECD and CEA, from a presentation by Alan B. Krueger, Council of Economic Advisers, United States of America, Jan. 12, 2012.
On the horizontal axis is the country’s Gini coefficient, the most commonly used measure of inequality (zero represents perfect equality among a country’s citizens and 1 means, roughly, that one person gets all the money in a society). On the vertical is what labor economists call inter-generational earnings elasticity, or IGE — roughly a measure of how likely it is that if you’re rich (or poor), your children will be, too. In a society with perfect equality of opportunity, the child of rich parents would have neither a higher nor a lower income than the average, yielding an IGE of zero.)
The curve ranks countries along two dimensions. Moving horizontally from left to right shows income inequality, as measured about a generation ago, becoming higher and higher across countries. During the early to mid-1980s, Finland, Sweden, Norway and Denmark were the most equal, the United Kingdom and the United States the least.
Moving vertically from bottom to top shows the average degree of stickiness between child adult earnings and the earnings of the family in which children were raised. In countries like Finland, Norway and Denmark, the tie between parental economic status and the adult earnings of children is weakest: less than one-fifth 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.
Higher income inequality would be less of a concern if low-income earners became high-income earners at some point in their career, or if children of low-income parents had a good chance of climbing up the income scales when they grow up. In other words, if we had a high degree of income mobility we would be less concerned about the degree of inequality in any given year. But we do not. Moreover, as inequality has increased, evidence suggests that year-to-year or generation-to-generation economic mobility has decreased.
Recent work finds that a worker’s initial position in the income distribution is highly predictive of how much he or she earns later in the career. Studying tax data on individuals’ earnings since 1937, the income mobility over the career has been stable since the 1970s, when all workers are considered as a whole. For men, however, there has been a decline in income mobility over the career since the 1970s. This decline has been offset by an increase for women, but the different pattern for women is probably a result of changes in labor force attachment over the career, rather than an increase in career mobility due to a fundamental change in the labor market.
More research has been done on intergenerational income mobility. Studies find that parent’s income is a good predictor of subsequent income. Studies that use income data averaged over longer periods of time for parents and children tend to find higher correlations between parental and children’s income. A reasonable summary is that the correlation between parents’ and their children’s income is around 0.50. This is remarkably similar to the correlation that Sir Francis Galton found between parents’ height and their children’s height over 100 years ago. This fact helps to put in context what a correlation of 0.50 implies. The chance of a person who was born to a family in the bottom 10 percent of the income distribution rising to the top 10 percent as an adult is about the same as the chance that a dad who is 5’6” tall having a son who grows up to be over 6’1” tall. It happens, but not often.
Another handy statistic for summarizing the connection between parents’ and children’s income is the Intergenerational Income Elasticity (IGE). Recent studies put the IGE for the U.S. around 0.4. This means that if someone’s parents earned 50 percent more than the average, their child can be expected to earn 20 percent above the average in their generation.
Causes of Inequality and Intergenerational Income Elasticity
The most important factor according to respondents was skill-biased technical change. A lot of activities people do at work have become automated as a result of computers and information technology, and much of this automation has favored people with the analytical skills to get the most out of the technology. This is one reason why the wage gap between those with a college education or higher and those with less than college education has soared in the last three decades. Attributing so much of the rise in skill differentials to shifts in demand across skill groups resulting from technological change alone may be a little misleading, however, as there also has been a slowdown in the growth of the supply of relatively highly educated workers.
The primary reason for increase in inequality in recent years is said to be technological change. Long behind are reasons such as international trade, minimum wage decreases, decline in unionization and rising immigration. All of these causes certainly did contribute to the rising gap between incomes, but technological progress, and more importantly the failure to adapt ones skills to this progress made the situation worse.
Rapid technological progress in the past 30 years resulted in a typical creative destruction process where new jobs and careers made certain types of old jobs obsolete (automated work). Some of these obsolete jobs were outsourced to Asia (even though one phenomenon followed the other, this doesn't imply a direct link of causality; one has to test this hypothesis to see if it holds). In addition, a lot low-skilled labour entered the market (mostly via higher immigration) that failed to adapt to the changes and were left stranded either at lower paid jobs or long-term unemployed. Poor education played an important role as well, while stagnating wages in the "dying" sectors only widened the gap. On the other hand, the innovative part of the equation was working quite well taking advantage of the new technological wave, thus further raising the income of the top 10% (hence the great disparity between college and non-college degree workers). It’s not hard to imagine how these two pulling forces (one downwards, one upwards) managed to widen the US inequality gap.
There’s an increasing consensus that for the United States and other rich countries, the double whammy of technological change, which favors the educated and skilled, and globalization, which has led to the loss of blue-collar and lower-end white-collar jobs, has taken a heavy toll on the incomes and life prospects of the poor and the lower middle class.
In particular, it is clear that the proliferation of high salaries earned in the financial sector has contributed to the rise in income inequality. The proportion of people in the top 1% who were from the finance and real estate industry nearly doubled from 1979 to 2005. And in 2005, executives from the finance and real estate sector made one quarter of the income in the top 0.1 percent.
Another factor that was cited was that in the 1990s there was increased globalization. People from other countries started coming in and taking up jobs, which lead to unemployment of the citizens of the country. Some have benefited as demand for the goods and services they provide has risen, but other workers have been left behind by globalization—they have seen their plant close with few new jobs available to replace it. The 2000s saw the worst record of job creation in 50 years, even before the recession that started in 2007. Recent research by David Autor, David Dorn and Gordon Hanson suggests that China’s very rapid adoption of cutting edge technology in many industries has had an even more profound effect on labor demand in the U.S. in the 2000s than in the 1990s.
There have also been important institutional changes that have contributed to the rise in income inequality. Union membership in the U.S. declined from 20% of employees in 1983 to 12% today. This is important because David Card and others have shown that unions affect the wage structure primarily by raising the wages of lower middle class workers so they can make it to the middle class. In addition, the decline in the real value of the minimum wage in the 1980s contributed to the rise in inequality, as David Lee and others have pointed out.
Lastly, tax policy has played a role in rising inequality. Although our tax code is still progressive, tax changes in the early 2000s benefited the very wealthy by much more than other taxpayers, compounding the widening gap in pre-tax earnings. As a result of reduced progressivity, the wealthy are paying some of the lowest tax rates in the history of the U.S.; average tax rates for the wealthiest 0.1 percent have been in decline for five decades.
The macro evidence is clear that the economy did not perform better after last decade’s tax cuts than it did after taxes were increased on top earners in the early 1990s. Income growth was stronger for lower and middle income families in the 1990s than it was in the last 40 years overall. There was more job growth in start-ups in the 1990s than in the 2001-2007 periods across all businesses; job growth was much weaker in the 2000s than in the 1990s. So there is little empirical support for the claim that reducing the progressivity of the tax code has spurred income growth, business formation or job growth.
India’s Great Gatsby Curve
Recent research by the World Bank suggests that India’s Gini has been rising steadily, even as extreme poverty drops, and was measured at 0.33 in 2005.
As inequality continues to rise in India, it can be said that India today would be close to where the United States appears, around 0.40, although the real Gini coefficient will only come when the latest numbers have been crunched.
If India conforms to the “Great Gatsby” curve — and there’s no reason to believe it would be an outlier — that would mean the country would have an IGE of around 0.4, corresponding to a Gini coefficient of 0.40. This IGE implies that if Indian citizens are earning 50 percent more than the average income today, their children will earn 20 percent more than average in their generation.
Over the past few years India's economic liberalization policy is being called into question more often without getting in specifics of why it is not working for many. India is an agriculture intensive economy – meaning most of the people are employed in the agriculture sector. Liberalization has been cited pleasurable without actually looking in depth. Only the sectors that have been liberalized have benefited from liberalization. But has farm sector been liberalized. Indian farmers are not allowed to freely sell their produce in the open market. They are not allowed to export the goods freely. These selective policies mostly favour the traders of farm produce rather than the producers with direct help from tax payer's money.
In India, there’s heated debate among scholars about whether India’s increasing integration into the global economy since the economic liberalization of 1991 has amplified inequality or attenuated it. The impossibility of observing what economists call the counterfactual scenario, that is, what would have happened without globalization, makes it possible for partisans on both the right and the left to stick to their guns.
Over the past decade, and except in 2009 and the last two years, the Indian economy has averaged a growth rate of around 8 per cent. This was a boom time for many companies, and a handful of politicians, bureaucrats and relatively unknown businessmen amassed an enormous amount of wealth. With the benefit of hindsight and the details that the media has published, it is clear that three factors drove this success: Access to capital, political patronage and a favourable international climate. The fastest-growing companies were those that borrowed to the hilt and "bought" political and bureaucratic largesse to secure land, licences and approvals. Most were in mining, construction, real estate, infrastructure and telecommunications. Many were led by first generation entrepreneurs whose companies did not figure on any ranking of companies in the 1990s. In fact, if one were to compare the list of the top 100 companies by market cap in 1990 with a similar list in 2010, one would find that only 42 companies made it to both lists. The exporters of minerals were also helped by the international market. The Western economies had not quite hit the skids and China was roaring on at 10 per cent plus growth.
Even as the debate over inequality continues, there is less and less focus on qualitative reasons. While statistics are shown to highlight the facts as they are, their interpretation and commentary leaves a lot to be desired especially if one wants to move in a positive direction.
In my opinion, it is pretty obvious that the correlation exists. The first years of your life are crucial to your development, IQ and education. Poor parents cannot follow up their children as well. By the time these children start school they have a disadvantage.
Today, in every good college in India, there’s a “management quota” for students who have to pay extra fees and reserve the seats. This is also nothing but more opportunity for a rich student and the opportunity cost has to be borne by the poor student. This adds to the concept of the Great Gatsby Curve.
No paid maternity leave, low child support, no good subsidized child care, etc. is also contributing towards the inequalities.
One of the major problems in India is the corruption at higher levels. The rich is becoming richer and the poor is becoming poorer. It takes away the platform for the poor people to try and do something, earn money.
Government should keep its taxation policies more progressive, higher at the higher income class people. It should also try to generate more employment, by giving subsidies to big MNCs if they employ a specific percentage of the country’s citizens. Government should also check on corruption and try to curb it. Globalization and Liberalization is important, but not at the cost of inequality.
1. Miles Corak (2013). “Income Inequality, Equality of Opportunity, and Intergenerational Mobility”, IZA DP No. 7520
2. Alan B. Krueger, Chairman, Council of Economic Advisers (2012). “The Rise and Consequences of Inequality in the United States”
3. Aaronson, Daniel and Bhashkar Mazumder (2008). “Intergenerational EconomicMobility in the United States, 1940 to 2000.” Journal of Human Resources. 43(1): 139-72.
4. J. D. Vance (2013). “The Great Gatsby Curve: Not So Great After All”
5. Corak, Miles and Patrizio Piraino (2010). “Intergenerational Earnings Mobility and the Inheritance of Employers.” IZA Discussion Paper 4876.
6. Robert Lenzner (2012). “Income Inequality From Generation To Generation” forbes.com
An intellectual property of Jitesh Daga. Please do not copy/reproduce in any manner.