The process we believe created income inequality matters more for the legitimacy of society than the actual level of inequality. Did the rich become rich by producing value or by exploiting the poor? What determined earnings, ability or inheritance/privilege?
The Occupy Wall Street protesters and their sympathizers in the media are angry about four trends they believe characterizes American capitalism.
1. Income inequality has been going up (true).
2. The Middle Class is stagnating (false).
3. Wealth is taken, not created (I believe false).
4. American income mobility is falling (false).
I will write about the middle class stagnation myth and about value creation next time.
The Bureau of Labour Statistics provides the NLSY97 dataset, tracking a large representative number of Americans. In addition to your current earnings, NLSY97 reports the income of your parents when growing up.
Of the Americans whose average income during the last five years put them in the “Top 1 Percent” richest, 7 out of 10 did not have rich parents (defined as the top 10% highest earning parents).
The richest 1 percent do not come from poor homes, they mostly come from upper-middle class homes. Note that because income is measured imperfectly, these numbers likely overestimate mobility.
Nevertheless, you get a similar result from the Forbes 400 list of the richest people in the United States. Forbes magazine lists the source of wealth :
“Two-thirds of the members of the Forbes 400 have fortunes that are entirely self-made.”
The share of billionaires who according to Forbes Magazine are self-made is higher in the United States than in Western Europe.
In addition to mobility between children and parents, mobility across life for the same worker is important. A recent study by Berkley Economist Emmanuel Saez and coauthors confirms that while income inequality has been getting worse, income mobility has not. Instead, driven entirely by women, upward income mobility has actually improved. Saez writes (emphasis in original) “long-term mobility has increased significantly over the last five decades.”
According to Saez, the probability that someone currently in the top one percent will remain in the top one percent five years from now is only around 60%, where it has remained for a very long time. The notion of a permanent elite taking hold of top incomes during the last few years is entirely a myth. There remains a substantial churn among the top one percent, with almost half dropping out every five years.
One common argument is that inter-generational income mobility in Northern Europe is higher than the United States. But even if that were true, it hardly proves that income mobility is low in the U.S, because those studies they cite find extremely high mobility in for example Scandinavia. Also a homogenous country will always appear to be more mobile than one made up of lots of groups. Not surprisingly, inter-generational mobility among Scandinavian-Americans in the NLSY97 is far higher than the U.S average.
Equally important, I believe these results are a statistical artifact. In Scandinavia, the income distribution is highly compressed. This means that even small and meaningless changes in income between parents and children appear as “mobility”.
Even if true mobility is identical, if one country has less income inequality, and if the amount of statistical noise in the income data is the same, the country with the even income distribution will appear to have more mobility as well. This is because measurement error/noise will move people around more in the compressed distribution.
Indeed the OECD finds that income inequality and inter-generational income mobility is highly correlated. If I am right, concluding that Scandinavia has lower inequality and higher mobility is double-counting equality.
Despite what the left claims, the United States is still a country with high income mobility. Another recent study by Pew found that:
“The vast majority of individuals, 71 percent, whose parents were in the bottom half of the income distribution actually improved their rankings relative to their parents.”
The study also confirms that to the extent there is lagging mobility in the United States, it is caused by racial disparities, having to do with skill levels. Pew confirms that American children from low income homes with high test scores have extraordinary high income mobility.
There problem is not with American capitalism as an economic system, but with the lingering inability to make capitalism work as well for African Americans and Hispanics as it does for Whites and Asians. This problem is what I and Reihan Salam focus on the latest issue of National Review, which I encourage you to buy.