The widening income gap has become a controversial issue in the United States, as liberals decry the decline of the middle class and conservatives argue that a healthy market economy must reward effort, enterprise and risk taking. But on the related issue of economic mobility, or individuals’ ability to move up the income ladder, most people appear to agree: Upward mobility is good.
Indeed, conservatives often cite economic mobility as the reason not to worry about widening income inequality. As long as people can rise, it doesn’t matter that some are very rich and others are many rungs below: Economic mobility means people are not trapped where they started.
But a growing body of evidence shows that economic mobility is not as attainable in the United States as many people think. Moreover, various studies show that economic mobility declines as income inequality increases, indicating that in coming years, it could become harder for people to move from poverty to the middle class, or from the middle class to the top.
“Recent studies suggest that there is less economic mobility in the United States than has long been presumed,” concludes a study by The Economic Mobility Project, conducted by The Pew Charitable Trusts, The American Enterprise Institute, The Brookings Institution, The Heritage Foundation and The Urban Institute. “The last 30 years have seen a considerable drop-off in median household income growth compared to earlier generations. And, by some measurements, we are actually a less mobile society than many other nations, including Canada, France, Germany and most Scandinavian countries. This challenges the notion of America as the land of opportunity.”
What drives economic mobility? “I believe that one of the great historical advantages of the United States has been the remarkable mobility of the U.S. workforce,” says Wharton finance professor Richard J. Herring, referring to workers’ ability to move from one location to another to pursue jobs, education and other opportunities for a better life, making the economy more efficient than if workers were fixed in place. The chance to rise is key to workers’ willingness and ability to move, he argues.
“Historically, this may have come from our origins as a land of immigrants who came to the U.S. to seek a better life and the opportunity to move West whenever economic conditions declined in the East,” Herring adds. “It also had much to do with expenditures on public education…. This traditional strength has diminished in recent years, for both transitory and secular reasons.”
Economic mobility involves two measurements, notes Wharton finance professor Nikolai Roussanov. First is “absolute” mobility, or the wealth of children compared to their parents. Then there is “relative” mobility, the ability of children to rise to a higher economic position than their parents occupied, as when children of the poor rise to the middle class.
While both types of mobility are important, relative mobility is especially revealing because it shows the extent to which people are trapped by circumstances of birth or are able to rise relative to others. The Economic Mobility Project study argues that relative mobility determines whether a country has a “meritocratic” society where people rise on effort, a “fortune cookie” society where status depends on luck, or a “class-stratified” society where children tend to end up in the same position as their parents.
Americans have historically viewed theirs as a meritocracy, but data shows that is not necessarily the case. “Most studies find that, in America, about half of the advantages of having a parent with a high income are passed on to the next generation,” the Economic Mobility Project study concludes. “This means that one of the biggest predictors of a child’s future economic success — the identity and characteristics of his or her parents — is predetermined and outside the child’s control.”
Clearly, prosperous parents can provide their children with good education and other advantages that are typically not available to people in lower income brackets. While some children of means will fail because of laziness, lack of talent or bad luck, the average person benefits from the initial leg up. Measuring inter-generational economic mobility by comparing the child’s income to the parents’, the Economic Mobility Project study finds that Americans are slightly more mobile than people in the United Kingdom, but less so than residents of France, Germany, Sweden, Canada, Finland, Norway and Denmark. In the latter four countries, people have two to three times the economic mobility of Americans.
A second study by the Economic Mobility Project found that “42% of children born to parents in the bottom fifth of the income distribution remain in the bottom, while 39% born to parents in the top fifth remain at the top.” Only about one-third of Americans were ranked as “upwardly mobile,” which required earning more than their parents as well as moving to a higher quintile on the income ladder.
A Gain for Women
Another study, based on tax data back to 1937, found that economic mobility for all American workers has been relatively stable since the 1970s but that important changes have taken place below the surface. Men have experienced a decline in economic mobility in recent decades, while women have enjoyed a gain. The figure for women, however, may be influenced by increased work outside the home.
In addition, “the ‘rags-to-riches’ story is much more common in Hollywood than on Main Street,” the Mobility Project concluded. “Only 6% of children born to parents with family income at the very bottom move to the very top.”
What causes economic mobility to increase or decline? A key factor is income inequality: the greater the inequality, the less mobility. Roussanov points out that it takes less additional income to move up from one quintile to the next if the pyramid is flatter, and more if the pyramid is steep. That may help explain higher mobility in Europe and Canada. “It’s not clear necessarily that the European societies actually have more mobility … because their income distribution is more compressed,” Roussanov says.
Most experts think other factors are at play as well, but income inequality is clearly rising in the U.S. In a January 12 speech at the Center for American Progress, Princeton economist Alan B. Krueger, chairman of President Obama’s Council of Economic Advisors, cited data showing a strong correlation between income inequality and a lack of economic mobility. Of the 10 developed economies in the study, the U.S. had the highest inequality and lowest mobility, measured by children’s success at rising to levels above their parents. Countries with the least inequality — Sweden, Finland, Norway and Denmark — had the highest mobility.
From 1947 to 1979, the rate of real (inflation-adjusted) income growth was about the same at all income levels in the U.S., Krueger said, citing Census Bureau figures showing 2.5% annual growth for the lowest-earning quintile and 2.2% for the highest. Then, from 1979 to 2010, annual incomes fell by 0.4% in the lowest quintile and rose by 1.2% in the highest. The middle class made up about 50% of the U.S. households in 1970 but just 42.2% in 2010. According to the Congressional Budget Office, from 1979 to 2004, real after-tax income rose by 9% in the bottom quintile of earners, 69% in the top quintile and 176% among the wealthiest one percent.
Citing a poll of economists, Krueger suggested that technological change, which reduces demand for workers without computer and other high-level skills, was the largest factor in rising income inequality. Among other major factors: international trade, the decline in the minimum wage when adjusted for inflation, the decline in unionization and rising immigration. In addition, the Bush-era cuts in income, capital gains and estate taxes helped further enrich the wealthiest Americans. Most European countries, Krueger noted, have more progressive tax systems than the U.S., helping to flatten the income pyramid.
Herring and Roussanov say American’s income mobility has also been damaged by declines in education. The U.S., says Herring, “has fallen well behind its peers in educational attainment at virtually every level…. Standards have clearly slipped. Fewer students are completing college and of those who do, a very small proportion have the skill or inclination to complete a degree in science or engineering.”
This has occurred, Roussanov adds, at a time when “the education premium has grown,” meaning workers with poor education have less chance of landing jobs that pay well. “There certainly is a sense that the educational system, particularly the primary education system, has deteriorated over time.” In the past few years, Herring adds, the financial crisis and its aftermath have contributed to the decline in economic mobility. Not only are millions of people unemployed, or earning less than they were before the crisis, but many are trapped because they cannot sell their homes.
“One of the reasons that U.S. recessions have been more shallow and shorter than in most other countries is that U.S. workers have evidenced a remarkable willingness to move to where the jobs are when they become unemployed,” Herring says. “Depressed conditions in the housing market mean that many workers who would otherwise be willing to move to areas with better job opportunities are stuck in homes they cannot sell. Presumably this will abate over time, but it is taking a very long time.”
Because inequality has been rising in the U.S., economic mobility can be expected to decline in the future, Krueger said in his speech. “In other words, the persistence in the advantages and disadvantages of income passed from parents to children is predicted to rise by about a quarter for the next generation as a result of the rise in inequality that the U.S. has seen in the last 25 years,” he noted. “It is hard to look at these figures and not be concerned that rising inequality is jeopardizing our tradition of opportunity. The fortunes of one’s parents seem to matter increasingly in American society.”
A Crumbling Foundation?
To many Americans, upward mobility is a core value, the foundation of the American Dream. But the intertwined issues of income inequality and flagging mobility have economic implications as well.
Pew found that growing numbers of Americans are pessimistic about the future, and doubt that the next generation will be as prosperous as the last. According to Pew, “In a March 2007 Pew Research Center poll, 73% of respondents — an 8 percentage [point] increase since 2002 — agreed with the statement, ‘Today it’s really true that the rich just get richer while the poor just get poorer.’”
If people believe they cannot get ahead, how will it affect the effort they put into their jobs, or obtaining other forms of enrichment, such as skills training or attending college? People trapped on low rungs of the ladder represent talent going to waste — overlooked innovators, researchers, entrepreneurs, educators, artists and business and political leaders Some researchers have suggested that growing inequality and falling mobility has driven consumers to borrow more to maintain desired levels of consumption, contributing to events like the housing bubble. Others argue that consumer demand, which is critical to economic growth, is undercut when fewer people are in the middle class and more are poor.
Krueger used a “back-of-the-envelope” calculation to show that from 1979 to 2007, the top one percent of earners saw their share of national income increase by 13.5%, equal to about $1.1 trillion in 2007. Because the wealthy save about half of their wealth increases, compared to 10% for the population as a whole, this redirected income reduced annual consumption by $440 billion. While he conceded this figure is open to challenge, he concluded that “these calculations make clear that the economy would be in better shape, and aggregate demand would be stronger, if the size of the middle class had not dwindled as a result of rising inequality.”
Solutions to growing inequality and immobility are politically controversial. Conservatives tend to argue that tax cuts and reduced regulation will spur economic growth, benefiting the poor and middle class as well as the wealthy. Liberals point out that the Bush tax cuts did not have that effect, and that the economy grew faster, and economic inequality was lower, when taxes were higher in the 1990s. Europeans tend to argue that their social safety net provides education, health care and other benefits that help people rise even if their parents were on the lowest economic rungs.
Herring and Roussanov suggest that the U.S. redouble its commitment to education. “A less well-educated labor force will inevitably be less mobile because it will lack the flexibility to adapt to changing economic conditions,” Herring says. “The decline in labor mobility leads to a decline in social mobility and to a society that few of us would prefer.
“Nonetheless, the notion that the U.S. is the land of opportunity with exceptional mobility is held widely in the U.S. and around the world,” he adds. “It is of significant value in motivating people to strive to do their best, but it cannot long persist without solid evidence backing it up. This will depend on fixing the educational system, which no one seems willing or able to tackle.”
Adds Roussanov: “We don’t want people to be trapped in poverty simply because they were unlucky enough to be born into it.”
Published: January 18, 2012 @Wharton
Business
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