Like father, like son? A comparison of absolute and relative intergenerational labour income mobility in Germany and the US

Stockhausen, Maximilian Article — Published Version Like father, like son? A comparison of absolute and relative intergenerational labour income mobility in Germany and the US The Journal of Economic Inequality Provided in Cooperation with: Springer Nature Suggested Citation: Stockhausen, Maximilian (2021) : Like father, like son? A comparison of absolute and relative intergenerational labour income mobility in Germany and the US, The Journal of Economic Inequality, ISSN 1573-8701, Springer US, New York, NY, Vol. 19, Iss. 4, pp. 667-683, https://doi.org/10.1007/s10888-021-09483-w This Version is available at: https://hdl.handle.net/10419/287460 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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A comparison of absolute and relative intergenerational labour income mobility in Germany and the US Maximilian Stockhausen 1 Received: 27 August 2018 /Accepted: 22 February 2021/ #The Author(s) 2021 Abstract Are children better off than their parents? This highly debated question in politics and economics is investigated by analysing the trends in absolute and relative intergenerational labour income mobility for Germany and the US. High quality panel data is used for this purpose; the SOEP for Germany and the PSID for the US. In Germany, 67% of sons born between 1955 and 1975 earned a significantly higher real long-run labour income than their fathers. Those with fathers from the lowest earnings bracket were particularly mobile in absolute terms. In contrast, the fraction of US sons earning more than their fathers is 60% on average for the same cohorts. Their share decreased from 66% in the 1956–60 birth cohort to 48% in the 1971–75 birth cohort, while it changed very little in Germany. Overall, absolute as well as relative labour income mobility is larger in Germany than in the US. This indicates that economic growth has been distributed more broadly in Germany than in the US. While the majority of German males has been able to share in the country’s rising prosperity and are better off than their fathers, US males continue to lose ground. Hence, Chetty et al. (Science 356:398–406, 2017) seem to be right when they say that the American Dream is slowly fading away. Keywords Absolute intergenerational mobility .Inequality .Labour income distribution . Relative intergenerational mobility JEL Classification: D63 .J62 The Journal of Economic Inequality https://doi.org/10.1007/s10888-021-09483-w *Maximilian Stockhausen [email protected] 1 German Economic Institute, Konrad-Adenauer-Ufer 21, 50668 Cologne, Germany Published online: 8 August 2021 (2021) 19:667–683 1 Introduction Is the promise of advancement and shared prosperity still alive in Germany and the United States (US)? A recent study by Chetty et al. (2017) creates some serious doubt, at least for the US. The fraction of children receiving a higher income than their parents has significantly fallen over time: 92% of children born in 1940 earned more than their parents compared to 50% in the 1984 birth cohort. They conclude that the American Dream is fading away. One major driver for this development is not low GDP growth but the unequal distribution of it. Although most indicators of economic inequality show lower levels of inequality in Germany over time, this does not need to automatically translate into a better situation in Germany regarding intergenerational income mobility (Organisation for Economic Cooperation and Development (OECD) 2015). This study is the first to analyse the development of absolute intergenerational mobility for Germany in a comparative framework with the US. During the last decades, both countries were exposed to similar major structural changes which were characterized by increasing global competition, negative impacts of the financial and economic crisis of 2007/2008 on economic growth and public debt, and increasing digitization and automatization (industry 4.0). In addition, Germany faced enormous changes due to the German reunification process. It has undertaken fundamental reforms of the labour market and the social security system (Agenda 2010) and is facing new challenges through the deepening of the European Union. As the EU becomes more heterogeneous, it becomes increasingly difficult to form political majorities and to implement good policies for better lives. One recent example is the distribution of refugees among the EU Member States. Nevertheless, all these changes both offer opportunities for social improvement, for example, by opening up new employment opportunities across a more globalized and digitized world, but also offer risks of social decline, for example, due to potential job losses which originate from technological changes and rising global competition. In addition, the life plans of many people have changed over the last decades: Younger cohorts appear to be more individualistic and live longer on average, and the number of single-person households or the number of single parents has increased. All this affects the economic conditions of individuals and households as well as the distribution of income (Martin 2006; Peichl et al. 2012, among others). A priori, it is not clear how and to what extent the changes described have affected incomes within and between different generations. Against this background, a simple comparison of annual incomes by repeated cross-sections is not meaningful if the hypothesis to be tested is that the promise of shared prosperity still applies across generations. The literature on absolute intergenerational income mobility is still very limited. This is mainly due to the need for long-lasting, high-quality data where parents and children can be linked. Chetty et al. (2017) exploit data from three different sources for the US and combine historical data from Census and Current Population Survey (CPS) cross-sections with panel data for recent birth cohorts from anonymized tax records. Other studies on the US use panel data from the Panel Study of Income Dynamics (PSID) and find similar patterns. Among others, Isaacs et al. (2008) show that absolute upward mobility has declined over the twentieth century. However, the period from 1947 to 1973 was characterized by an extraordinary high rate of growth, which has attenuated afterwards. This development is more pronounced for men’s earnings than for family incomes. Rising female employment explains this difference to some extent. Lopoo and DeLeire (2012), Bengali and Daly (2013), and Acs et al. (2016)all find similar patterns for the US; differences appear mostly due to different income definitions and sample periods. No such studies exist for Germany yet. Hence, this paper is the first to M. Stockhausen 668 calculate rates of absolute mobility for Germany and to directly compare these findings to the US using harmonized panel data. The main findings of the study are that 1) absolute intergenerational labour income mobility is larger in Germany than in the US and 2) there are differences in the evolution of absolute mobility over time between countries. 1 While the share of sons earning more than their fathers decreased from 66% in the 1956–60 birth cohort to 48% in the 1971–74 birth cohort in the US, absolute labour income mobility changed very little in Germany for the same cohorts and varies around an average of 67%. In addition, relative mobility is higher in Germany, especially at the lower tail of fathers’labour income distribution. This is also reflected by a lower intergenerational labour income elasticity coefficient that is about 0.3 in Germany compared to about 0.5 in the US. However, the size of the gap depends, for example, on the treatment of zero and low-income observations (also see Schnitzlein 2016). The rest of the paper is structured as follows: Section two describes the methods and data used to estimate absolute and relative intergenerational mobility in Germany and the US. The results are presented in section three. Detailed robustness checks are provided in the online appendix. Section four summarizes and discusses the results. 2 Methods and data Measures of absolute intergenerational mobility can be applied to describe the extent of income differences between parents and their descendants at comparable points in time. According to Chetty et al. (2017), let ys idenote the permanent labour income of son iand let yf idenote the permanent labour income of his father. The rate of absolute mobility Ais then the fraction of sons earning more than their fathers: A¼1 N∑i1ys i≥yf i no ;ð1Þ with Nbeing the number of sons. In contrast, the concept of relative income mobility measures the change in income positions between generations. Relative income mobility only takes place when the child’s position in the income hierarchy of his generation changes relative to the position of his parents in their generation. Levels do not matter and improvements in the standard of living or shared prosperity measured in real GDP per capita growth are not covered. Relative mobility is estimated by transition matrices and intergenerational labour income elasticities. The latter is commonly used in the literature and can be derived from estimating log ys i  ¼αsþβlog yf i  þγCf iþδDs iþεs i;ð2Þ in an OLS framework. The notation is the same as above; in addition, Cf iand Ds iconsist of control variables including two polynomials of fathers’and sons’age as well as the number of years in the son’s labour income average. 2 Standard errors are clustered at the family level. All 1 All results on Germany refer to West Germany due to data limitations for East Germany that accrue mostly from the division of Germany after World War II. Germany and West Germany are used interchangeably. 2 Other non-linearities along fathers’labour income distribution are not further investigated in this study, since Schnitzlein (2016) provides sufficient evidence against their importance in Germany and their limited impact in the US. Like father, like son? Intergenerational labour income mobility 669 estimations are based on large and long-running survey data sets. The Socio-Economic Panel (SOEP) is used for Germany and the Panel Study of Income Dynamics (PSID) for the US. The SOEP has been collected annually since 1984 on behalf of the German Institute for Economic Research Berlin (DIW). It captures a large variety of socio-economic characteristics at the individual and household level, including different types of income (Goebel et al. 2019;SOEP 2016). The PSID has been collected since 1968 on behalf of the University of Michigan. It encompasses similar information as the SOEP. Between 1968 and 1995 it was collected annually. Since 1995 it is conducted every two years (Panel Study of Income Dynamics (PSID), public use dataset 2018). Both data sets allow information from parents and children to be linked over time. The analysis is focused on labour income, which is individual gross annual earnings from work, including wages and salaries from dependent employment or selfemployment plus bonuses. All labour incomes are deflated to the base year 2010. For this purpose, the SOEP provides a historical series of consumer prices that can directly be applied to the data. The CPI-U-RS was used for the US. 3 Thus, real labour incomes of fathers and sons are compared throughout the paper unless stated otherwise. In a first-best world, we would have access to complete income histories of the whole (working age) population and, thus, lifetime incomes. Since this is just an utopia and lifetime incomes are usually not fully captured by household surveys, they have to be approximated for both parents and children. For this purpose, the existing literature recommends calculating a multi-year income average in a phase of life in which annual incomes are highly correlated with permanent or lifetime income. If incomes are averaged over multiple years at this stage, a good approximation of lifetime income and the related position in the income distribution should be obtained and life-cycle, as well as attenuation biases in mobility estimates, are reduced but not fully eliminated (Solon 1989; Haider and Solon 2006;Grawe2006;Nybom and Stuhler 2016; Schnitzlein 2016). For Germany, Bönke et al. (2015)findthatannual earnings from the mid-30s to mid-50s correlate most strongly with lifetime earnings. Therefore, there will be a focus on those years for approximating lifetime earnings. Another major issue in approximating lifetime earnings from a limited number of annual income observations is the treatment of outliers, especially valid zero earnings observations that arise, for example, due to times of unemployment. Average and median income levels, absolute mobility rates as well as intergenerational elasticity coefficients tend to be sensitive to their inclusion since they affect the variance of income observations (Couch and Lillard 1998; Dahl and DeLeire 2008). In general, there are three alternatives to handle this problem: 1) including all zero observations, 2) defining a lower income limit as a cut-off threshold for trimming or bottom coding, and 3) dropping all zeros. The first option is associated with two problems. Zero observations might introduce large life-cycle bias. Since only a snapshot of incomes is used for approximating lifetime earnings, we could draw observations from a period in life with extraordinarily high unemployment that is not representative for the rest of the working life. Since the deviation from regular earnings to zero earnings is huge in most cases, this might distort the true earnings capacity of an individual very much and, thus, measures of absolute and relative mobility are biased. In addition, some model specifications do not allow the usage of zero income observations, for example, the log-linear specification of 3 The impact of using different price indices on absolute income mobility is well documented in Chetty et al. (2017) for the US. In general, using the CPI-U-RS results in conservative mobility estimates since this index tends to overstate inflation. See the online appendix for more information on sample construction and variables used. M. Stockhausen 670 OLS to estimate intergenerational elasticity coefficients. 4 In this case, the second option might be preferable. However, defining a lower income limit faces similar problems as option one, and the choice of the lower limit is arbitrary in most cases but can have large effects on mobility estimators. The third option might reduce life-cycle biases but can also cause sample selection biases. Nybom and Stuhler (2016) analyse the effects of such choices on life-cycle biases in detail and find significant differences. They conclude that it would be preferable to include zero and missing income observations in theory but doing so increases the vulnerability of estimates to life-cycle biases. Schnitzlein (2016) also investigates the influence of different lower income limits on estimates of intergenerational elasticity coefficients in much detail. He finds a significant influence of different lower cut-off points on the estimates: The higher the cut-off value, the higher the elasticity coefficient and, thus, the lower intergenerational mobility. Having that in mind, the main analysis is conducted excluding zero labour income observations to reduce potential life-cycle biases. In particular, all annual labour incomes below 1200 Euro (EUR) or 1200 US-Dollars (USD) are dropped. The threshold is set in accordance with a proposal by Schnitzlein (2016) and excludes implausibly small annual labour income observations. Nevertheless, the cut-off point is arbitrarily chosen, and it is not said to be the ideal cut-off value for analysing absolute income mobility. As a robustness check, the main results are also presented for different income cut-off points and for the case where valid zero labour income observations are included (see the online appendix for detailed results). Furthermore, the main analysis is limited to father-son pairs only. Mothers and daughters are left out since they have undergone large changes in their employment behaviour and scope, especially in Germany, which would otherwise distort the results. A high rate of absolute mobility would be an expression of the changed integration of women in paid work, but not an indicator of the fulfilment or failure of the promise of prosperity. For a similar reason, the analysis of Germany focuses on West German father-son pairs only. As a result of the German reunification, there have been numerous biographical breaks and opportunities that would otherwise distort the results. Furthermore, the labour income of East German fathers could not be observed before 1990, which would further limit the investigation period and the number of observations. Accordingly, the generation of West German fathers includes the 1928–1954 birth cohorts. Their labour incomes were directly observed in the years 1984 to 1993 in the SOEP when the fathers were between 30 and 60 years old. The generation of US fathers includes the 1925–1954 birth cohorts, everything else equal. For the calculation of permanent labour incomes, the fathers must have at least five valid income observations during this period, whereby the first income observation must be from 1984 (the reference year of the fathers). The generation of sons consists of the 1955–1975 birth cohorts in both countries. Here, the incomes are observed in the years from 2005 to 2016 in the SOEP and from 2005 to 2015 in the PSID, when the sons were aged between 30 and 55 years. The labour incomes of the sons are also averaged over at least 5 years, whereby the first income observation must be from 2005 (the reference year of the sons). The determination of a reference year ensures that the samples and the generation-specific average incomes are representative for the population in those years to the largest possible extent (Galler 1987,296ff.).The effects of different weighting strategies are discussed more detail in the online appendix.The fathers’reference year results from the starting year of the SOEP interviews. The same year is also applied to the US sample for reasons of comparability. The chosen year for sons takes into account 4 To avoid this technical problem, zeros could be recoded to very small positive numbers. However, this does not solve the initially described problem. Like father, like son? Intergenerational labour income mobility 671 that the generations do not overlap in time given the specific age intervals and that the number of possible father-son pairs is maximized. As additional robustness checks show, the choice of baseline years does not affect the qualitative results and the quantitative results are only marginally affected. 5 However, the restriction that fathers and sons must have at least five valid income observations starting from the reference year could distort the results due to panel attrition, as long as panel attrition is not determined solely by random factors. Using longitudinal weights instead of cross-sectional weights does not alter the results. In fact, using longitudinal weights marginally increases absolute mobility at the lower end of the fathers’distribution and marginally decreases it at the upper tail. Reducing the observation period to 3 years, for example, and thus lowering the problem of panel attrition at the cost of potential life-cycle and attenuation biases, leads to very similar qualitative and quantitative results: Absolute income mobility at the lower end tends to increase so the main results can be regarded as conservative estimates of absolute mobility. 3Results 3.1 Descriptives Using the data described above, a total of 320 father-son pairs can be identified for Germany and 619 for the US (see Table 1). In Germany, fathers’average real permanent labour income amounts to 40,618 euros per year. Labour income was averaged over 9 years on average, while the mean age of fathers was 49 years. Sons’average real permanent labour income is 44,288 euros per year. Labour income was averaged over 10 years on average, around the mean age of 41. The fathers tend to be slightly older than their sons and have a lower real permanent labour income on average. In the US, fathers’average real permanent labour income amounts to 62,340 USD per year. Labour income was averaged over 9 years on average, while the mean age of fathers was 47 years. Sons’average real permanent labour income is 87,540 USD per year. Labour income was averaged over 6 years on average, around the mean age of 43. Again, the fathers tend to be slightly older than their sons and show a lower mean real permanent labour income on average. Due to the age differences, fathers’lifetime incomes may tend to be slightly overestimated compared to their sons, if earnings continue to rise with age. In this case, the results represent a lower bound of absolute income mobility: If the fathers’incomes are overestimated, then the fraction of sons with incomes larger than their fathers’incomes would actually be larger and is underestimated in this study. The problem would be more severe if fathers would be younger than their sons. However, averages are only of limited information when analysing income distributions. In order to better understand what the margins of the generation-specific lifetime income distributions look like, kernel density functions are used as depicted in Fig. 1. Permanent labour income is more unequally distributed among sons than among fathers in both countries, although the change is more pronounced in the US. In addition, lifetime labour income inequality is substantially lower than cross-sectional labour income inequality that is usually used in distributive analyses. This is not a new finding, but it highlights once more that income mobility equalizes distributions over time and that age-income profiles are heterogeneous which should be kept in mind when looking at cross-sectional analyses of the income distribution (Bönke et al. 2015). 5 The results are available from the author upon request. M. Stockhausen 672 Table 1 Sample Statistics for Sons and Fathers (Weighted) GER USA Median Mean Std. Dev. Min Max Median Mean Std. Dev. Min Max Sons’real labour income €41,802 €44,288 €18,929 €2868 €142,094 $60,145 $87,540 $120,524 $7647 $1,278,717 Fathers’real labour income €35,517 €40,618 €18,669 €10,757 €149,768 $54,561 $62,340 $47,872 $10,191 $625,464 Average number of years of sons’income observations 11.00 9.94 2.49 5 12 6.00 5.70 0.46 5 6 Average number of years of fathers’income observations 10.00 9.18 1.44 5 10 10.00 9.00 1.69 5 10 Sons’average age 41.50 41.16 4.52 32 53 43.00 43.07 5.05 34 52 Fathers’average age 49.50 49.18 5.66 35 58 46.50 46.69 7.10 34 59 Number of father-son pairs 320 619 Notes: Labour incomes are reported in 2010 EUR for Germany and in 2010 USD for the USA. Annual earnings observations below 1200 EUR/USD per year are excluded Sources: SOEP v33.1 (1984–2016); PSID (1984–2015); own calculations Like father, like son? Intergenerational labour income mobility 673 Labour income at the tails, especially at the upper tail, is more often observed among sons. The right shift in the density function is especially pronounced in the sons’generation in Germany. This induces an improvement of the sons’generation over their fathers, which is also reflected by the increase in real median labour incomes across generations in both countries. Although the relative increase of median income is larger in the US, it comes at the cost of an increase in inequality between generations. In the US, the generation-specific Gini coefficient rises from 0.315 for fathers to 0.450 for sons. In Germany, the Gini coefficient increases from 0.224 to 0.230 across generations. This is a remarkable difference between countries and another hint that economic growth and prosperity was shared more broadly in Germany than in the US. Figure 2compares the average real labour incomes of sons and fathers by labour income quartile groups. Quartile groups are formed for fathers and sons separately. The 45-degree line helps to show that average permanent labour income has increased in almost all quartile groups across generations in both countries. If a son ends up in the same quartile group as his father, Fig. 1 Distribution of Permanent Labour Incomes. Notes: Labour incomes are reported in 2010 Euros for Germany and in 2010 US-Dollars for the USA. Annual earnings observations below 1200 EUR/USD per year are excluded. For scaling purposes, labour incomes above 300,000 USD are excluded. Sources: SOEP v33.1 (1984–2016); PSID (1984–2015); own calculations Fig. 2 Permanent Incomes by Labour Income Quartiles. Notes: Labour incomes are reported in 2010 Euros for Germany and in 2010 US-Dollars for the USA. Annual earnings observations below 1200 EUR/USD per year are excluded. Sources: SOEP v33.1 (1984–2016); PSID (1984–2015); own calculations M. Stockhausen 674 It turned out that about 67% of sons born between 1955 and 1975 in (West) Germany earned a real long-run labour income higher than their fathers. The same share is about 60% in the US. Those with fathers in the lowest earnings groups were particularly successful in improving their status in both countries. However, absolute mobility is higher in the lower part of fathers’labour income distribution in Germany and slightly higher in the upper part in the US. Another important difference between the two countries is that absolute mobility is constant across sons’cohorts in (West) Germany while it has decreased in the US. The results for the US are, hence, largely in line with comparable findings in Chetty et al. (2017), which cover an even longer time period. They find a remarkable decline in absolute labour income mobility across time: About 92% of sons born in 1940 earned more than their fathers compared to about 50% for sons born in 1984. This gives them a good reason to say that the American Dream is fading away. According to these findings, in combination with the findings on relative labour income mobility, it cannot be said that American conditions prevail in Germany since both mobility indicators show a more positive picture in Germany. Social advancement is possible to a larger extent in Germany than in the US where most of today’s sons are still better off than their fathers. The qualitative results are also robust to the choice of different cut-off points and the inclusion of zero labour income observations used for approximating permanent labour incomes. Nevertheless, the quantitative results are affected by treating zeros differently, especially in the lower parts of the income distribution. The treatment of zeros should, thus, always be made explicit. A limitation of the study is its focus on fathers and sons. There is no sufficient data on women that would allow a differentiated analysis of absolute and relative labour income mobility by employment types. This would be a necessary precondition because women have undergone marked changes in their employment behaviour and scope, especially in Germany, which could distort the results. A high rate of absolute mobility would be an expression of the changed integration of women in paid work, but not an indicator of the fulfilment or failure of the promise of prosperity. Nevertheless, results from Chetty et al. (2017) indicate for the US that the share of daughters who earn more than their fathers tends to be remarkably lower compared to sons. This is very likely to be the result of differences in working hours (part time work) and payment. The share of women working in lower paid service sectors is still larger than for men. It is likely that similar results hold for Germany. However, there is also a conversion between genders across time that should not be neglected and is another indicator of social advancement. In any case, labour income mobility could be further increased by promoting educational mobility, especially to those with low-income parents. Labour market demands and social conditions will continue to change, for example, through digitization, and the ability to lifelong learning will become even more important. Employment biographies and incomes of people from different cohorts will be affected differently by these new challenges. It is therefore not possible at present to predict how absolute and relative intergenerational income mobility will develop in the future. The favourable economic development of the past years, however, supports the belief that the promise of social advancement and increasing prosperity that is inherently connected with the concept of a social market economy will continue to be fulfilled in the future, at least in (West) Germany. Supplementary Information The online version contains supplementary material available at https://doi.org/ 10.1007/s10888-021-09483-w. Like father, like son? Intergenerational labour income mobility 681 Acknowledgments I am very grateful to my colleagues at the German Economic Institute as well as to Daniel Schnitzlein and the participants of the 13th International German Socio-Economic Panel User Conference in Berlin for many helpful comments and suggestions on earlier drafts of the paper. I would also like to express my sincere thanks to the anonymous reviewers and my editor in charge for many helpful comments and suggestions. Furthermore, I would like to thank Tina Krell and Regina Sager for proofreading my work. All remaining errors are in my responsibility. Funding Open Access funding enabled and organized by Projekt DEAL. The author is employed at the German Economic Institute. He received no extra funds. Declarations Conflict of Interest The author declares that there is no conflict of interest. Open Access This article is licensed under a Creative Commons Attribution 4.0 International License, which permits use, sharing, adaptation, distribution and reproduction in any medium or format, as long as you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons licence, and indicate if changes were made. The images or other third party material in this article are included in the article's Creative Commons licence, unless indicated otherwise in a credit line to the material. 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