Festival of Economics

One of the saddest things about primary school reunions is to find out that income inequality among classmates has remained unchanged throughout the years: the rich child is still rich and the poor child is still poor.

Dynamic and static inequalities are equally important. It is not just the distance between those with higher and lower incomes that matters, but also the odds that lower-paid workers will close the gap over the course of their lifetime. The great divide between the richest and poorest 20 per cent of the US population was for a long time deemed socially acceptable because it was integral part of a society with high levels of social mobility. The US was considered to be the land of self-made individuals: guaranteeing equal opportunities was a strong intent, even though it was not always achieved. Social mobility means that even when inequalities are most glaring, it is still possible for those in the lowest income bracket to climb up the social ladder. In fact, as a Report to the US Congress recently acknowledged, the latest studies show that the rise in income and earning disparities has gone hand in hand with a reduction in social mobility. Meanwhile cross-country data on static and dynamic inequalities show that the greater the income gaps, the lower the social mobility across generations, a correlation which, ironically enough, is known as the Great Gatsby curve. When static inequalities become too wide and the wealthiest 10 per cent of the population receives 50 per cent of the national income and owns up to 70 per cent of accumulated wealth, as is the case today in the US, it is unlikely that social mobility can reduce such large discrepancies. At the same time if society ossifies, killing off the possibility of reversals in positions on the income ladder, static inequalities tend to increase too. It is precisely for this reason that we need social mobility: to avoid perpetual and ever-expanding differences in incomes. If the same families are not always in the top income bracket, then it is possible to avoid having wealth forever concentrated in the same hands and transmitted from one generation to the next, as in the dynasties of the past. But if this doesn’t happen, the disparities in accumulated wealth will tend to become entrenched, widening the gap between those who must work to survive, and those who, in addition to their human capital, can invest a stock of wealth from a large sum of inherited money.

Assessing the nature and extent of social mobility is especially important in countries such as Italy, whose economy is stagnant or recording very low growth, but which have experienced a Golden Age during which national income increased at rates that are now only seen in emerging economies. Wealth is the result of progressive accumulation over time. When average incomes are not growing, it is most unlikely that the lifetime earnings of workers can close the gap between them and those with inherited wealth, who might have not worked a single day in their life. In countries with low growth, inherited capital guarantees wealthy rentiers higher incomes than those enjoyed by workers. And given that family fortunes are generally transmitted from parents to children, unlike merit and creativity, many of the most talented are obliged to lag behind. Inherited wealth therefore becomes more important than personal abilities in determining the social position of an individual with the result that we end up further and further away from equal opportunities.

Many institutions can foster social mobility. Perhaps the most important ones are those linked to the education system, which should enable the children of the least well-off to receive a high level of education and cultivate their talents. But even when it comes to school and education admission, the disparity of treatment between classes persists. Another particularly important area for the promotion of social mobility is labour market access. The more difficult it is to get your foot on the ladder, the harder any upward mobility will be. Financial markets and the banking system play a very important role because they have the power of providing funds to people with clever ideas but with no means. Loans are also a way of investing in the human capital of those who do not have rich families.

Real estate – the main source of household wealth and the most commonly inherited asset – is another major element of social immobility. High revenues can often be generated from properties on the basis of factors that have little to do with talent. In some countries, such as Italy, it is possible that the concentration of wealth in the real estate market has played a role in the country’s social immobility. The fiscal and tax systems play a decisive role in changing/determining the relative size of? revenues from capital and labour. Taxes on capital tend to be lower than those on labour because capital is much more mobile: if you overtax it, it tends to move. This makes it more difficult to reduce the inequalities in the distribution of capital gains which is why these tend to be more marked than in the distribution of earnings. Addressing this problem requires coordination between countries in the taxation of capital, something which remains elusive even within the European Union.

There is a global dimension to the problem of unequal opportunities that is often overlooked. Overall, the higher the barriers to migration and the tighter the restrictions on the mobility of people, especially of the most highly-qualified, the harder it will be to move within societies. It is one of the most serious problems that the European welfare state must address today, which is now threatened, more than by the sovereign debt crisis, by the attempt to hinder the mobility of workers within the EU.

Tito Boeri
Scientific Director of the Festival of Economics

More: 2015.festivaleconomia.eu