The Eurozone and the Great Gatsby Curve

The significant rise of income inequality in Europe and the U.S. since the 1970’s has fostered a heated debate on the primary driving force behind inequality. On one side, there is the idea that if the root cause of inequality is technical change, incomes at the top grow much faster than average because talented and hard-working individuals make significant economic contributions, and therefore, increasing inequality should not be a concern. However, on the other side, there is the idea that the fundamental factor for the growing incomes of the rich is the worsening of institutions and rent-seeking, and that the resultant increases in top shares have not translated into higher economic growth and are therefore undeserved.

Regardless of its origin and merit, higher inequality could hurt economic performance by reducing intergenerational mobility. There would be a significant cost for the economy and society if children from low-income families do not have the equivalent opportunities to develop and apply their talents as their more fortunate counterparts from better off families, who attend better schools and draw on a network of family connections in the job market. The tendency of countries with higher income inequality to be countries where a greater fraction of economic advantage and disadvantage is passed on from parents to children has been coined the “Great Gatsby Curve” by the Chairman at the U.S. President’s Council of Economic Advisors, Alan Krueger. If this relationship is true, the significant rise of inequality in Europe in the aftermath of the Great Recession will cause an undesirable decrease of social mobility in the future and, consequently, a deterioration of economic performance and opportunity.

To throw some light on this, we have recently examined a unique cross-country data set, the International Social Survey Program (1992, 1999 and 2009). The survey asks each respondent to compare his present job with his father’s job when he was 16 years old. Job status mobility may be a more appropriate measure of social mobility than earnings mobility because high-income parents may have children who choose relatively low paying high status jobs.

Using a sample of seventy countries, we look for the long-term determinants of upward mobility, downward mobility and immobility in job status across a generation. In particular, we consider income inequality, the degree of development, the level of human capital, the quality of institutions, ethno linguistic and religious fractionalization, the role of government, and social infrastructure.

In accordance with previous literature, better institutions and higher religious fractionalization favor upward mobility, while deterring downward mobility. Additionally, higher levels of past GDP result in less upward job status mobility and more downward job status mobility. Most importantly, we find a clear negative effect of lagged inequality on upward intergenerational job status mobility and a robust positive effect of lagged inequality on downward intergenerational job status mobility. Moreover, the impact of lagged inequality on intergenerational immobility is in general not significant. The rest of the factors are generally not important.

Thus the findings support the contention of the “Great Gatsby Curve”, income inequality harms intergenerational mobility. The bottom line for the Eurozone is clear: the significant rise of inequality prevailing in the Eurozone today will cause an undesirable decrease on social mobility in the near future and, consequently, a deterioration of economic performance due to the misallocation of talent and the deepening of rent-seeking activities. This adverse impact on growth will in turn reduce opportunity and increase income inequality again.