Income mobility and education

As goats on a tree, reaching for the best leaves, we all strive to be the ones at the top. But even in America, the land of opportunity, only good climbers make it. And lately even the fittest seem to be having a hard time.

The table below shows the percentage of people who moved from a given group in the income distribution to any other one, between 1994 and 2004. (The data come from the Panel Study of Income Dynamics, and the income measure is household taxable earnings.) The lowest degree of income mobility occurs among the poorest and the wealthiest: 58% of households in the bottom 20% of the distribution stay there, and 60% of those in the wealthiest quintile don’t move either.



Pooling people from all ages together, however, can be misleading. The typical earnings profile over a lifetime is hump-shaped: earnings start low, rise up until the individual is in her 50s, then begin a slow decline, and fall sharply with retirement. Because of this non-monotonicity, movements up and down the earnings distribution may have little to do with climbing the social ladder.

As an example: suppose the economy is populated by two individuals, one of whom is 35 and earns $45,000, and the other one is 55 and makes $75,000. So the older person is at the top of the distribution. Ten years later, the young individual has accumulated experience and earns $65,000, whereas the older person, now 65, has retired and doesn’t earn any labor income. The younger individual is at the top of the earnings distribution now. If we were oblivious to the age of these individuals, this two-person society would look remarkably mobile: the poorer person moved to the top and vice versa. In reality, the observed mobility is the product of the normal course of earnings over peoples’ lives.

The fortunes of a person are more likely to change early in life. Twentysomethings are less likely to be attached to a house, a family, or a job. They job-hop, experiment, go back to school. Over time, some people land a dream job —or a “comfort job”— and stay there. And some others simply grow roots: they have mortgages to pay, and spouses and kids to drag along. We also become more risk averse with age.

The data bear these intuitions: 67% of households whose head was between 22 and 29 in 1994 had switched quintiles ten years later; 54% of those between 30 and 39 did so, about the same as among the 40-49 age group.

Things get much more interesting when I look at mobility within education groups. Schooling is probably the single most important factor determining a person’s chance to “make it.” People with less education are less employable. They also experience smaller changes in productivity, so their earnings curve is less steep. And they have fewer opportunities to fill high-powered positions —the sort that provide a pay boost if one is successful. In this, however, the evidence doesn't support my expectations.

Between 1975 and 1985, and within the group of college graduates, 61% of households moved to a different economic class, whereas 59% of high school graduates were mobile -barely a difference. And twenty years later, 54% of college grads and 60% of people with a high school degree were mobile. (See chart.)

Click to enlarge


What made the economic ladder more slippery for college grads? Following the reasoning above, maybe people have less appetite for risk, and are taking jobs that are safer but also offer fewer opportunities to leap-frog over income classes. Starting up a business, for instance, is one of the riskiest endeavors one could pursue. But statistics show that animal spirits have not subdued —the fraction of entrepreneurs and self-employed has risen over the last 30 years.

A second explanation is that unobserved ability, not education, is behind opportunity. A couple of decades ago earning a college degree was a major feat. Only the well-off, highly-motivated and bright ever put their feet in a University. Nowadays going to college is almost a given. As a result a college degree has become a weaker signal of one’s competence. Highly capable individuals still get ahead, but the vast majority of college graduates do not belong to that breed.

Finally, but not less importantly, it might be a problem of too many grads chasing too few jobs with incentive-based pay. In spite of all the talk about stock options, the number of positions with (significant) variable compensation has grown more slowly than the body of individuals with a University diploma. More well-educated people land jobs without the power or the incentives to rise fast on the pay scale.

This calcification of the white-collar society is worrying. More and more individuals go to graduate school in order to earn that M.B.A., M.A., or even Ph.D., that will give them an edge over their peers. That behavior is perfectly rational, and yet self-defeating. The latest batches of college grads remind me of hamsters on a wheel rather than goats.

Technorati tags: economics, income mobility, inequality, income inequality, upward mobility

Income mobility in the U.S.

Five weeks ago the Wall Street Journal (WSJ) commented on a study (pdf) by the Treasury Department on the income mobility of American families. The newspaper proudly reported that 58 percent of households who were in the lowest quintile (the poorest 20 percent) of the income distribution in 1996 had moved to a higher income category by 2005. Almost 25 percent jumped into the middle or upper-middle income groups, and 5.3 percent made it all the way to the highest quintile. (See Table 1.) Of those in the second lowest quintile, almost 50 percent moved up and 17 percent moved down. The WSJ’s comment on table 1 stopped there. The evidence was described as "a stunning show of income mobility."

Table 1. Income mobility of American households, 1996 to 2005 (click to enlarge)


Note: an entry in the table is the percentage of households that move from the row quintile (1996) to the column quintile (2005). Examples: 28.6 percent of households that were in the lowest quintile in 1996 had moved to the second quintile in 2005; 50 (26.7+15.1+7.9) percent of households in the second quintile moved to a higher quintile.

Let’s look a bit longer at this cup of water, and then decide whether it’s half full or half empty. First of all, look at how “thick” the NW-SE diagonal of that table is. The poorest households have a 42 percent chance of staying in their original group; no other group displays such a degree of immobility, except the very richest. In the second richest group, 70 percent of households stay put or move up; 69 percent of households in the top group stays on top.

So this is my one-line reading of Table 1: many people do move, but they don’t get far from the echelon they started at. (To be fair, people in the middle of the distribution do have a good shot at movin’ on up: 42 percent of them climb to the upper-middle or upper class; 25 percent join the lower or lower-middle class.)

Second, moving up one step when you’re poor means much less in terms of absolute income than when you’re rich. According to data from the Survey of Consumer Finances (SCF) (pdf), in 1995 the median family (*) in the lowest quintile had an income of $8,500 (in constant prices of 2004). If that household had moved to the next higher group in 2005, its earnings would have risen to $25,700, i.e. a $17,200 increase. A household that had moved from the middle to the fourth group would have seen its income increase from $37,800 to $68,100, that is, a $30,300 increase. (See Table 2.)

Table 2. Median incomes, by income percentile (thousands of dollars, at constant prices of 2004) (click to enlarge)


The WSJ also presented a graph with the increase in median income between 1996 and 2005, by groups (see chart nearby). The chart shows that “the poorer an individual or household was in 1996 the greater the percentage income gain after 10 years.” For households in the first quintile, for instance, income rose by 90.5 percent between 1996 and 2005, whereas households in the second quintile only got 34.8 percent richer. Families in the top 10 percent of the scale experienced a 2.9 percent raise.

A 90.5 percent increase doesn’t make you rich when you’re making so little money. Using data from Table 2, a family in the lowest quintile would have seen its earnings increase by $7,700 (90.5 percent over $8,500). For a household in the second quintile, income would have risen by $7,552. (See Chart 2.) Considering that their incomes in 2004 would have stood at $16,200 and $29,300, respectively, nobody would say that they "made it."

Chart 2. (click to enlarge)
















The US is a society of extreme inequality – there isn’t much argument about this. Inequality is less of a problem, however, if people have a chance of becoming significantly wealthier regardless of how poor they are. Inequality reflects the extreme rewards to success; income mobility measures the opportunities to achieve that success.

Unfortunately, my impression is that large income gains are less likely than the WSJ believes. Over the next ten-year period, I would expect most households to experience changes of plus or minus $10,000 – clearly not enough to climb the income ladder.

(*) The median family is the one in the middle of the income distribution, with half of the families having higher incomes and half having lower incomes.

Technorati tags: economics, income mobility, inequality, income inequality, upward mobility