Inequality, Social Mobility and Growth : Reflections on Recent Literature

There has been a recent deluge of academic work and elite media analysis of the inequality phenomenon and its societal implications. As is customary, pundits of both political persuasions have extracted findings which reinforce their ideologies to make sweeping pronouncements about the pernicious long term effects of inequality, or lack thereof.

This is a shame because much of the new research and analysis sheds important new light on the issue, particularly its downstream effects on social mobility and long term economic growth. Indeed, a sober evaluation of the recent work does much to advance our understanding of the precise explanations for social stagnation and why, for example, some metropolitan areas fare better than others in the United States.

The Latest Research and Analysis

The primary source of new data comes from the American Economic Association and its summer volume of The Journal of Economic Perspectives (JOEP). This periodical produced a stellar symposium on the subject of inequality based primarily on new data from The World Top Incomes Database, a collection of tax and other economic information on the long-run distribution of income share at the top of various countries.

The symposium generated fascinating papers that argued for and against the ascendancy of the richest earners in countries across the world and especially in the United States. While there is broad based agreement on findings such as the unprecedented rise in top income share in countries like the US and Britain and much slower increases in top incomes in Japan, France and Germany, distinct differences remain as to what governments should do to address current circumstances from a public policy perspective.

The Top 1%

In an article that appears in the aforementioned JOEP, authors Facundo Avaredo, Anthony Atkinson, Thomas Piketty and Emmanuel Saez state that narratives which attempt to explain recent increases in inequality simply by way of supply and demand for skills are insufficient to explain the extreme top tail of earnings income distribution. Additionally, they state that only evaluating earned income when assessing the issue without taking into consideration capital income (which includes inherited wealth) is incorrect. The authors point to the top 1% as the most staggering statistical culprit in the United States. From 1976 to 2011, the top 1 percent share of income more than doubled from 9 percent to 20 percent.

In most of continental Europe and Japan, where similar technological and productivity developments have taken place, the authors find that institutional and policy differences are instrumental in explaining inequality at the very top. They point to taxation as a key indicator of income distribution in the top 1%. In countries such as the US and Britain where top marginal income tax rates were reduced dramatically following World War II, the total share of the income by the 1% grew the most. Moreover, the authors go on to cite that since 1960, there is no correlation between economic growth and top tax rates. They state that all rich counties have grown at approximately the same rate since this period despite wide variations in tax policies.

Finally, the authors point to recent reductions in capital taxation and the decline in macroeconomic growth as two underlying explanations for increased income growth at the top. Inheritance flows which are described as monetary values passed on through bequests and gift have dramatically increased in places like France and Germany and to a lesser degree in the US since 1950. To this extent, the authors note that trans-continental tax policy has accommodated private wealth transfers resulting in sustained inter-generational wealth among the elites.

Evolving Market Forces

In an important piece by Financial Times columnist Tim Harford, we are asked to ponder the following question about inequality, “Should we care”? Harford notes that indeed we should care for reasons that have to do with both process and outcome.

Citing analysis in the JOEP symposium from Steve Kaplan and Joshua Rauh, Harford first points to significant increases in executive pay across different lines of business. Not simply confined to the much maligned bank executives, lavish income increases have been realized in varying industries ranging from senior law partners to top athletes. They note that market forces in the form of freely agreed contracts are the real reason behind such drastic increases in pay at the top. The emergence of winner take all markets, where the best entrepreneurs, be they fund managers, software developers or actors take an increasing amount of the available national income. He casts asides the emotionally attractive though incorrect notion of banker fat cats simply stealing the have nots' money based on poor corporate governance and financial greed. Harford importantly notes that market shifts have benefited the most talented among us.

Harford’s goes on to make perhaps his most profound point in the remaining portion of the piece. He closes by addressing the connection between an unfair process and a harmful outcome for society immersed in pervasive economic inequality. He notes that one feeds the other and that the more unequal a society becomes, the greater the incentive for the rich to protect their economic position above the rest using a poignant metaphor of “pulling the ladder up behind them”.

Harford notes that the plutocrat class has the ability to move their children into the best neighborhoods, universities, and has access to the best internships and jobs. The wealthy can shape national policy and media narratives through political donations and media ownership.

Harford argues that all of this feeds the notion that the more unequal our societies become, the more we all become prisoners of the supposed inequality. He goes on to note that the wealthy do all they can to prevent their children from slipping down the ladder while the poor see the best schools, colleges, and other important formative programs become increasingly unaffordable. Harford concludes that the idea of a market based society is that everyone can reach their full potential by way of a good education and hard work and that is inevitably slipping away. He notes that unfortunately, somewhere along the way this basic theory of economic ascendancy fell by the wayside.

The Economic Case for Social Mobility

In a piece by Brookings Institution Fellow, Richard Reeves, the author argues that the most overlooked aspect of reductions in social mobility is the connection to economic growth. Reeves argues that economic growth, of course, matters the most because it is the most basic way of creating jobs and improving real incomes. Furthermore, he states that growth is the primary engine of absolute social mobility ensuring that most people are better off than their parents.

The author offers new research conducted by Professor Raj Chetty and his team of researchers from Harvard and Berkeley. The researchers evaluated the link between economic growth and mobility in 741 “commuting zones” across the United States. The researchers found a strong link between growth and relative mobility, but found that variations in economic growth did not account for variations in mobility when other factors were taken into account. The difficulty that Reeves finds is determining the precise nature of the causal relationships. He notes that therefore while growth in and of itself appeared to have little effect, it is growth that creates the tax base to fuel schools and community programs, jobs that help families put food on the table and it is growth that boosts spending on community activities.

Reeves points to a 2010 OECD study that makes the case for greater social mobility as a necessary condition for growth. He compares and contrasts areas such as Des Moines and Salt Lake City where the chances of someone born into the poorest fifth of the income distribution scale making it to the richest fifth is 10 percent. As opposed to cities such as Charlotte and Atlanta where the equivalent odds are less than 5 percent.

Reeves points to three main reasons why entrenched mobility reductions are harmful to long term growth:

1)Permanent Welfare Class – Reeves notes that a sustained and semi-permanent welfare class is a drain on public resources. Money pegged for welfare programs could be put to more productive uses such as pre-K education, infrastructure and job programs. He states that the inheritance of poverty is both a fiscal drag as well as a moral stain.

2)Reductions in Labor Supply – Reeves states that the lack of opportunities for upward movement could retard the supply of available labor. He points to the rise in the number of people with low skills who are not only unemployed but are detached from the labor market altogether. Harford postulates that the retreat from work represents a loss of faith in the economy’s ability to provide upward movement.

3)Loss of Human Capital – Harford compellingly argues that low rates of upward mobility from the bottom imply a loss of human capital. Essentially, when smart yet poor children can’t escape their born into class, their skills are lost to the economy as a whole. He points to a an analysis by the Boston Consulting Group that estimated that closing the educational gap in Britain could add 4 percent a year to GDP by the year 2050.

The author closes by noting that mobility and weak rates of economic growth are typically seen as separate policy challenges. Often they are construed as economic and moral, to be evaluated on distinctly divided grounds. However he notes, this could turn out to be terribly incorrect as we need economic growth to create opportunities, but conversely we need to bolster opportunity to foster economic growth.

Conclusions

As we approach the 50th anniversary of Martin Luther King’s “ I Have a Dream Speech” and the Civil Rights Movement’s “March on Washington”, it is all the more important that we consider social mobility not only in a broad sense but within social, racial, and ethnic parameters. The latest bout of research shows that income inequality is not only increasing in the United States and among the very wealthiest in society, but that such growth is having deleterious effects on labor markets and macroeconomic conditions around the world. While much has been made about the fairness of such unequal societies, perhaps the argument should be framed on the negative economic effects that inequality begets.

As a number of developing nations such as China, Brazil, and India begin to join the ranks of the rich world over the next generation, they would be wise to implement policies that reduce concentrated wealth among a few, if for only to ensure more robust and sustained economic growth occurs. And as the US and the rest of the rich world continue to recover from the Great Recession, they too should begin to think of social mobility and inequality mitigation as a public policy imperative. The future of our economies and the dreams of the less fortunate depend on it.