Date posted: 15/06/2022 8 min read

Meet the Great Gatsby Curve

How do we beat the inequality mapped by the Great Gatsby Curve? A strong labour market helps but it’s not the whole answer.

In Brief

  • A tight labour market can reduce discrimination in hiring, but is not a cure-all for issues of inequality.
  • The Great Gatsby Curve shows that countries with greater income inequality tend to have less intergenerational earnings mobility.
  • One solution is to equalise the starting points, so all children can access good education, healthcare and a safe home.

Economists poke their noses into everything, and one of the more audacious nosepokers was 1992 Nobel Prize winner Gary Becker. He took the economist’s bag of tricks into areas it had never been before, including marriage, sleep and crime.

Another off-piste topic he looked at was discrimination. Becker argued that an employer who discriminated was being irrational, sometimes driving up his or her own costs when just as qualified but shunned people would have done fine.

I remember vividly an example of his ideas playing out in real life. As a financial journalist in Tokyo in the 1980s, I was invited to see the flash new forex dealing room of a Japanese bank. “Yes,” said the proud manager, “we have 23 people here – 17 dealers and six women.” Meanwhile, an American bank I visited later was chortling over having a free pick of the best women Japanese graduates.

It’s not only Japan. One recent analysis of New Zealand firms found that women in high-skills businesses were paid 16% less than their male colleagues for the same contribution to the business. But that difference vanished when either the firm faced stiff competition for staff in its industry, or when the wider labour market was tight. In both scenarios, it meant potential discriminees could tell the discriminator to stick their lowball offer.

Another example? Black men in the US. They can find it hard to get jobs, suffer worst in recessions and even in good times have higher unemployment than many other groups. But the good times rolling makes a huge difference to their chances. By the end of the long 2010s business expansion their unemployment rate was down to 5.2%. The same findings come up anywhere the national statisticians keep unemployment rates by ethnicity. A strong labour market has the power to undermine discrimination.

As an economist you may be tempted to think that the first-best anti-discrimination plan is to run macroeconomic policy to keep the labour market as hot and competitive as possible. Even bigoted employers will be driven to hire people they mightn’t have otherwise. And that’s true, as far as it goes. But it’s not enough.

The persistence of inequality

An unsettling idea has come along, now generally known as the Great Gatsby Curve, sarcastically named after F Scott Fitzgerald’s 1925 novel. (Credit for the underlying idea generally goes to Miles Corak, currently at the City University of New York, and credit for the name to Alan Krueger, chair of the Council of Economic Advisors in President Obama’s day.)

The book featured Jay Gatsby, who had risen from a poor farming background, via making a fortune in bootleg liquor during Prohibition, to mix with the mega-rich in the boom years of America’s Roaring Twenties. In his day, it looked as if anybody could become anything: opportunity beckoned and people could grasp it and live the American Dream. Many immigrants to Australia and New Zealand would have shared a similar vision of doing well in fairer, more open societies than the ones they left behind.

But the Curve says the opposite: economies are typically not equally open to everyone. The game is stacked. The already well-off stand the best chance of staying that way, while the already disadvantaged stay at the bottom of the pile.

The Curve – economists are the only people who can call a straight line a curve – shows that countries with greater income inequality tend to have less intergenerational earnings mobility. (See graph.) That’s fancy wording for the probability that you’ll end up in a higher earnings bracket than your parents. If you are a peon working the rich rancher’s land in deeply unequal Argentina, your chances of becoming a rich rancher yourself are half of five-eighths of a small taco.

“If you are a peon working the rich rancher’s land in deeply unequal Argentina, your chances of becoming a rich rancher yourself are half of five-eighths of a small taco.”

Australia and New Zealand don’t scrub up too badly. We’re both on the good side of the trend (more social mobility than you’d expect for countries with our level of income inequality). But we are not as open and equal as we might be – for that, the gold standard of low inequality and high mobility remains, you guessed it, the Scandinavian model.

Figure 1. More inequality means less generational earnings mobility (the Great Gatsby Curve)

More inequality means less generational earnings mobility (the Great Gatsby Curve)Source: “Inequality from Generation to Generation: The United States in Comparison” by Miles Corak, IZA Discussion Paper No. 9929, May 2016. Click image to enlarge.

How to level the playing field

In a way, the Curve shouldn’t have been such a surprise. The wealthy can afford the tutoring and extra-curricular enrichment that gets their kids into the premium schools and colleges that lead to the megabucks partnerships at prestige investment banks. Your kids and mine don’t get a fair look in.

And that diagnosis suggests its own solution: equalise the unfair starting points. As Alan Krueger put it, “take steps to ensure that all children have access to quality education, health care, a safe environment and other opportunities that are necessary to have a fair shot at economic success.”

Are we doing enough, in Australia and NZ, to line up everyone at the same starting tape? I doubt it. We try, but when you see league tables ranking schools by their pupils’ exam results, the outcomes are still heavily dominated by their socioeconomic catchments. Extra funding for lower decile schools isn’t the effective leveller we’d like it to be.

I was a scholarship boy from a middle-class background. Scholarships helped pay my way through secondary school, university and post grad. I wonder how many kids today are getting the same chances to have a crack at a decent go in life?

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