The Great Gatsby Curve - Intergenerational social mobility and equality - graph by Miles Corac

This remarkable exhibit shows the quaintly named “Great Gatsby Curve”. It indicates the economic prospects of the next generation are strongly correlated with the degree of inequality of the country they and their parents live in.

It is adapted from a speech given last month by the Chairman of President Obama’s Council of Economic Advisers, Professor Alan B Kreuger, titled The rise and consequences of inequality in the United States. You can also see a slideshow of his speech here.

The vertical axis, showing Intergenerational Earnings Elasticity (IGE), measures the relationship between earnings of parents and the earnings of their grown-up offspring. Brazil has a very high score, meaning a Brazilian whose parents earned 100% more than average can expect to earn 60% above the average in her generation. In Denmark however, parent’s income is a very minor predictor of their offspring’s income.

The horizontal axis, the Gini coefficient, is a common measure of inequality. A score of zero means perfect equality and a score of one means perfect inequality e.g. all the income is held by only one person. In this instance the Gini shows the degree of inequality by income in a country e.g. Brazil is a considerably more unequal country than Denmark.

It seems very clear that the degree of inequality of incomes is closely correlated with inequality in the next generation. It has important political implications, particularly in the US at the moment. As Justin Wolfers puts it:

If income inequality in one generation can be linked to unequal opportunity in the next, then income inequality can’t just be dismissed as the politics of envy.

There’s nevertheless been the usual methodological dispute about the research behind Professor Kreuger’s paper as well as a bit of a spat between economic bloggers about what the findings mean for US economic policy. It doesn’t seem like the integrity of the findings is at issue now, just what it means and what should be done.

It’s important to note that the horizontal axis is not a measure of current levels of inequality in the sampled countries. Since the vertical axis is about the earnings of the current generation, the exhibit shows income inequality data from the mid 1980s.

However Professor Kreuger notes there’s been a significant increase in inequality in the US since the 1980s. He says that if the cross-sectional pattern shown in the exhibit were to hold into the future, the IGE for the US would rise from 0.47 to 0.56.

In other words, the persistence in the advantages and disadvantages of income passed from parents to the 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. It is hard to look at these figures and not be concerned that rising inequality is jeopardizing our tradition of equality of opportunity. The fortunes of one’s parents seem to matter increasingly in American society.

If you’re parents were wealthy in the 80s, you would’ve been better off growing up in the US or the UK than in Canada, Australia or Sweden. But if they weren’t, one of the other Nordic countries would’ve been your best bet.

As an aside, I think the variation between countries also supports my frequent exhortation to be wary about applying overseas examples to Australian conditions. Canada and the US are a notable case – neighbouring countries at similar stages of economic development with closely integrated economies, yet markedly different intergenerational income mobility.

The second exhibit speaks for itself. It’s from Charles Murray’s new book, Coming apart: the state of white America 1960-2010, which I’ve just started reading.

Note: (1) The version of the curve I’m using is by Professor Miles Corac and is somewhat revised from that in Professor Kreuger’s paper and includes more countries, one of them being Australia; (2) The name ‘Great Gatsby Curve’ presumably (?) reflects the “land of opportunity” meme – F. Scott Fitzgerald’s fictional Jay Gatsby rose from a pitiful North Dakota farm to a fabulous Long Island mansion.

Family incomes in the US, 1959-2009, by Charles Murray