The Great Gatsby Curve describes the positive empirical relationship between cross-sectional income inequality and persistence of income across generations. The scatter plot shows a correlation between income inequality in a country and intergenerational income mobility (the potential for its citizens to achieve upward mobility).
At the cross-country level, the Great Gatsby Curve was recognized early by Hassler, Mora, and Zeira, Andrews and Leigh, Björklund and Jäntti, and Corak, but the research was popularized by late professor and Chairman of the Council Economic Advisers Alan Krueger during his speech at the Center for American Progress in 2012 and the President's Economic Report to Congress. Krueger dubbed the positive relationship between inequality and persistence, the "Great Gatsby curve", and he introduced it into popular and political discussion.
Explanation of the chart The Great Gatsby Curve illustrates the strong positive correlation between the concentration of wealth in one generation and the capability of the following generation to move up the economic ladder compared to their parents (see Economic mobility). The horizontal axis shows the inequality, measured by a country's Gini coefficient (a higher value means a more unequal distribution of income in society). The vertical axis shows persistence, measured by the intergenerational elasticity of income (IGE), where a lower intergenerational elasticity means there is higher income mobility in that country, i.e. children have a higher chance to earn more money than their parents.
The Great Gatsby curve shows the relation between income inequality and intergeneration mobility (in this case between Gini Index and Intergenerational Elasticity respectively) and signifies that the relationship is positive and quite strong. So, it indicates that in countries with higher income inequality it is harder to overcome your parents' income level and vice versa.
The countries with the most income equality and with highest intergenerational mobility are in the left bottom part of the graph; these are mostly Nordic countries with Canada, Australia, Japan, New Zealand and Germany not far from them. On the contrary, in the right top, countries with the greater level of inequality have less upward mobility, for example, the United Kingdom. The United States is in the middle.
Etymology The name of the curve refers to the novel The Great Gatsby (1925) by Francis Scott Fitzgerald. The classic novel dramatises the gap between intergenerational wealth and the newly rich during the Jazz Age. The main character of this story, Jay Gatsby, was born in an impoverished family, but he earned lots of money and dramatically improved their social level during the years.
Judd Cramer, former staff economist at the Council of Economic Advisers, related the story of the birth of the Great Gatsby Curve to Miles Corak in responding to an email he sent him in September 2016:
The short version of the story is: Reid Stevens and I were working with Alan for his speech at the Center for American Progress about the middle class. We got data from your paper and elsewhere and made the figure at Alan's direction. Alan wanted a name for it; something that spoke about the rich staying rich, etc. We were in a meeting in the chairman's conference room and he asked us to go brainstorm names. We went back to the room where many of the junior staffers sat together, we called it the bullpen, and after we explained the curve to all the staffers, we each put down one suggestion. Reid may remember the also-rans better than I do but I wrote down the Great Gatsby curve because of Gatsby's trouble trying to jump social classes in spite of his money. A few of the other staffers teased me for my suggestion. None of the others were too great in my opinion; I remember a lot of the other names playing on white picket fences/silver spoons in their names.We then walked the list back over to Alan and his chief of staff, David Vandivier. Alan read all the names and chose the Great Gatsby curve. During that time in DC, Alan was in the business of promoting New Jersey wines and he gave Reid and me a bottle for our help with the speech that went well a few days later. I think that touches on the major points.
Krueger predicted that "the persistence in the advantages and disadvantages of income passed from parents to the children" will "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." The Great Gatsby Curve was used to advocate policies that aimed to reduce income and educational inequality by raising the minimum wage, providing subsidies for health insurance through the Affordable Care Act, etc.
Causes The Great Gatsby Curve describes a relationship between the wealth of prior generations and the level of income of their children. According to the model, the correlation is strongly positive and can be transferred into reality.
There are many factors affecting the well-being of people and one of them is education. Education can be determined by parental income and their overall position in society.
Human capital can be measured by the level of education, experience, knowledge, skills, etc. An individual's level of income highly depends on their human capital, which is collected and improved throughout the years starting from early age. The opportunities for the accumulation of human capital can be determined by the social status of one's family. The quality of education is affected by the quality of schools. The schools are funded by a budget (provided by the state) which differs for every school district and the financial contribution is distributed between all the students in the community. The opportunities of individuals are improved by better connections, since they provide us with an easier entry into a certain market. Everyone's identity is created by their social interactions, experience and direction of their development.
Richer neighborhoods tend to have better funded schools and public services, although the life in them is more expensive. Therefore, parental income plays a big role in the choice of a neighborhood and the community, since finances limit peoples' options, causing the strong, positive correlation between income inequality and persistence of income across generations.
Criticism Journalist Timothy Noah argued:
you can't really experience ever-growing income inequality without experiencing a decline in Horatio Alger-style upward mobility because (to use a frequently-employed metaphor) it's harder to climb a ladder when the rungs are farther apart.
Another journalist argued that a connection between income inequality and low mobility could be explained by the lack of access for un-affluent children to better (more expensive) schools and if this enabled access to high-paying jobs; or to differences in health care that may limit education and employment.
However, some argue that the apparent connection may be an artifact of heterogeneous ability variance across nations, raising questions about the need for intervention. It was shown that the way the intergenerational income elasticity is defined is, by design, associated with inequality. Harvard economist Greg Mankiw noted that "this correlation is not particularly surprising", showing that comparisons of more diverse groups (like the US) with less diverse groups (like the population of Denmark) will automatically exhibit this phenomenon even when there are in fact no differences in the processes of mobility between these groups, i.e., the curve is an artifact of diversity. His quote:
Germans are richer on average than Greeks, and that difference in income tends to persist from generation to generation. When people look at the Great Gatsby curve, they omit this fact because the nation is the unit of analysis. But it is not obvious that the political divisions that divide people are the right ones for economic analysis. We combine the persistently rich Connecticut with the persistently poor Mississippi, so why not combine Germany with Greece?
A blog by M.S. at The Economist replied to Mankiw's counter-argument as follows:
The argument over the Great Gatsby curve is an argument about whether America's economy is fair. With his Germany/Greece and Mississippi/Connecticut analogy, Mr Mankiw has stumbled on a very convincing point: whether you are rich or poor in Europe or America depends to a great extent not on your own qualities or efforts, but on where you happen to be born. America is not a meritocracy, Mr Mankiw is saying; not only do those born rich tend to stay rich and vice versa, just being born in one state or another makes a huge difference to your lifelong earnings. Amazingly, he seems completely unaware that this is the case he's just made.
Economist Paul Krugman has also countered Mankiw's arguments in his column.
The GGC suggests that a society can simultaneously pursue equality of opportunity (measured by mobility) and equality of outcomes (measured by cross-section differences). More specifically to the US, the curve challenges the recent viability of the "American Dream" by linking inequality to limits on opportunity, questioning whether the US has chosen to accept unequal outcomes in order to create equal opportunities. Thus, the Great Gatsby curve has been popular regarded as a challenge to Americans' beliefs.
Theories of the Great Gatsby Curve
The following theories look at different aspects of inequality besides the Gini index such as inequality in family structure, parents education and their occupational attainment, social influences, etc.
Family investment models In the classical model of intergenerational mobility, parents divide income between investments in child's education and own consumption. Brighouse and Swift (2006, 2014) and Lazenby (2016) discuss these tradeoffs. The idea of this model is that parental investments do matter. Some factors for making decisions between these investments are, for example, psychic stress or credit constraints. Psychic stresses are associated with poverty and deprivation and can suppress the child's ability to create human capital and for adults to convert the human capital into income. Credit-constrained families show higher intergenerational elasticities of income than unconstrained families because of the effect of additional income on investment in children. An important notice is that the degree to which adjustments in the cross-section income distribution are linked with changes in the distribution of credit constraints, ability, or altruism, can each lead to producing relations in the Great Gatsby Curve.
Skill models A second model that can produce the Great Gatsby Curve is based on skill formation. From this point of view, the adult outcomes are influenced by the cognitive and non-cognitive skills acquired by dealing with a sequence of family inputs in order to produce both type of these skills during childhood and adolescence.
Nevertheless, there are two differences in comparison with the classical model. First, children are affected differently by family inputs throughout different periods of time, i.e., timing of family influences matters. Second, the inputs provided by families are more thorough than just purchasing educational investment. For example, inequalities in a way families are built (e.g., single parenthood versus family of two parents), matter. Furthermore, studies have supported the thesis that less affluent parents invest less in their children than more affluent ones. Also the impact of their investments dominates in case of less affluent parents at each investment level.
Social models