Great Gatsby! What income inequality and immobility means for entrepreneurship

The ‘Great Gatsby’  curve has been making news again – one of my favorite terms in economics right now. A recent article in the Economist magazine argues that that the so-called Great Gatsby curve, which shows that countries with higher income inequality also have lower income mobility, is particularly worrying.

The problem, as the Economist explains, is that people who want to defend gross inequalities of income in countries like America often argue that income inequality is okay as long as you have income mobility: if today’s burger-flipper can become tomorrow’s prosperous Richard Branson with a little grit and hard work, society is still fair. The problem with this thesis is the Great Gatsby curve. It shows that the greater the distance in a country between rich and poor, the harder it is to go from poor to rich or vice versa. Countries don’t compensate for income inequality through income mobility; they tend to be either fair or unfair on both metrics at the same time.

While, on the face of it, one would assume that this problem would be immediately seized upon and become part of a larger debate on the economic and political structures exasperating income inequality and immobility, that is not necessarily the case. For one, the relationship between inequality and immobility with entrepreneurship is not immediately apparent . In this post, I’ll review some negative effects the Great Gatsby curve can have on entrepreneurship.

As I have illustrated in another blog post, entrepreneurship has three faces: productive, unproductive, and destructive. Productive entrepreneurship is the identification, evaluation and exploitation of opportunities to provides new value to society and an economy as a whole. It can take the form of one-off-trade, sustained small business entrepreneurship, or even within larger (non- and for-profit) organizations. Unproductive entrepreneurship, on the other hand, is the exploitation of opportunities that have benefits for only a single party, while detracting from society and the economy as a whole. Ubiquitous examples are bribery, excessive lobbying, insurance fraud, etc. , which is called ‘rent’ seeking by many economists. Destructive entrepreneurship is the exploitation of opportunities that have socially negative consequences typically associated with black markets. The international drug trade, human trafficking, and poaching are all forms of entrepreneurship that have severe negative effect to society and the economy as a whole. Of course, what one calls ‘productive, unproductive, and destructive’ is open to debate, with proponents wanting to argue with stories and images why their form of entrepreneurship is ‘valuable’ and not ‘valueless’.

Typically in the past, economists have tried to tease out the relationships between entrepreneurship (i.e. only small business entrepreneurship) and innovation or income equality or mobility or economic growth. Turning the causality the other way, however, and defining entrepreneurship in its three types, brings up some worrying insights.

First, high income inequality and immobility is shown to have a negative impact on society as a whole. Richard Wilkinson, Professor Emeritus of Social Epidemiology at the University of Nottingham, charts the hard data on economic inequality, and shows what gets worse when rich and poor are too far apart: real effects on health, lifespan, even such basic values as trust. As these basics decline to the majority, health, lifespan, and trust diminish as well as productive forms of entrepreneurship . Why? Productive forms of entrepreneurship require a certain amount of basic social needs to be met, and those needs are roughly health, lifespan, and trust. Productive entrepreneurship is about taking on some amount of risk to offer new products and services that will greatly improve the living standard of society as a whole, which also creates real economic growth. If they fail, they need to know they will not be stigmatized and dignity ruined. However, if an individual perceives her health, education and distrustful community and culture as high, there is no belief that one should take on risk to offer anything of new value to these other people. Instead, a more reliable option is to act (unproductively or destructively) entrepreneurially on the black market to benefit yourself and family members. Those with economic power in these conditions also have little belief that their actions should be directed for the good of society as a whole. Instead, setting up a system that rewards themselves through bribes leads to an increase in unproductive entrepreneurship. The institutionalization of inequality through captured laws and regulations, the awful legacy of colonialism, or stereotypes creates cycles of distrust, income inequality and immobility. This again reduces the chances of the next generation of potential productive entrepreneurs to identify opportunities and act upon them.

Second, high income inequality and immobility stymies productive entrepreneurship because it inhibits fair competition and reduces overall demand. Productive entrepreneurs identify gaps in supply and demand by responding to the needs of the people. When income and mobility are unequal, monopolist engage in supply side economics to raise prices, protect their position, and thus become less efficient. Moreover, they may engage in unproductive entrepreneurship by capturing regulators and policymakers to bend laws in their favor. Innovation and creativity is thwarted because income inequality and immobility offers less access to capital for productive entrepreneurs. As monopolists have an increased power to act entrepreneurially in their own interests, they reduce the overall incentives for potential productive entrepreneurs and their new value becomes unrealized.

Contrastingly, some prominent thinkers argue that monopolists create new jobs since they have command over a larger amount of resource and therefore should be left alone to do so. Inevitably examples like Cornelius Vanderbilt and Jay Gould, who became wealthy through railroad ownerships in the 19th century, are said to have led to a railway unification of the USA. Without these few rich and visionary people we would not have had the expansion of railways an exponential economic growth. History shows however that Congress created the Interstate Commerce Commission (ICC) in 1887 to indirectly control the business activities of the railroads through issuance of extensive regulations. Congress also enacted antitrust legislation to prevent railroad monopolies, beginning with the Sherman Antitrust Act in 1890. The reason Congress took these actions is that monopolists were harming competition, exploiting labor (Chinese, minorities), and creating unfair prospects for potential entrepreneurs.

Increased income inequality and immobility also reduces overall demand in an economy since fewer people have the economic power to buy new products and services. The lack of purchasing power by the majority translates into little possibility for productive entrepreneurship to be successful. On the other hand, the monopolistic few however can only sleep in one, albeit glorious, bed at a time and ride in one luxurious car at a time. Instead, the economy is skewed so that cycles of disadvantage get more acute and desperate for the many, which promotes unproductive (insurance fraud, bribery, etc.) and destructive (gang membership and crime).

Ultimately, the effect of rising inequality and immobility is that people view ‘control’ differently. Social psychologists like Sheena Iyengar show us that mental health of humans and non-human animals is highly linked to independent choice based on a perception of control. While chance is always a factor, when potential productive entrepreneurs view choice being reduced due to lack of markets and capital, their perception of control is thwarted. A ‘locus of control’ has been found by psychologists as a key element of all entrepreneurship. However, as individual perceive their situation as limited in choice, so too they see productive entrepreneurship as less of a viable option. The overt lack of control reduces happiness, resources availability, and perception of making a difference in a community or society. Instead, disenfranchisement and marginalization take hold, which promotes unproductive and destructive forms of entrepreneurship.

I believe there are two ways in which societies can direct people into productive entrepreneurship rather than unproductive or destructive. First, is to reduce income inequality by supporting a minimum wage increase, reduce health care costs, and capping high incomes through redistributive tax system. Finding the right balance between support and competition is never easy, but the Gatsy Curve is good evidence that society should reduce run away inequality and immobility. Equality begins with a comprehensive system of fair taxation and health care readily available. The second is to boost mobility by providing better access to affordable education, reduce the degree of  institutionalized marginalization of racialized or sexualized groups (minority and sexual orientation) through progressive laws, and to encourage more stable early childhood experiences by allowing parents flexible work spaces. In the United States, the recent overturning of DoMA provides some clear progress in reducing stereotypes but the Travyon Martin case underscores the countries continued problems of offering equal access to minority groups. Flexible work spaces, allowing working from home or 4 day work days, creates space for parents to spend time with their children and a build a sensitive and caring new generation.  For it is the next generation that will transform society and the economy through productive entrepreneurship.

See Articles

Baumol, W. J. (1990). Entrepreneurship: Productive, unproductive, and destructive. Journal of Political Economy, 98(5), 893-921. Retrieved from http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=9103252727&site=bsi-live

Baumol, W. J., Litan, R. E., & Schramm, C. J. (2007). Good capitalism, bad capitalism and economics of growth and prosperity. New Haven, Conn. and London: Yale University Press.

Honig, B., & Dana, L. P. (2008). Communities of disentrepreneurship. Journal of Enterprising Communities: People and Places in the Global Economy, 2(1), 5-20. doi: 10.1108/17506200810861221

Schumpeter, J. A. (1994). Capitalism, Socialism, and Democracy. London, England: Routledge.

http://www.economist.com/blogs/democracyinamerica/2013/07/great-gatsby-curve?fsrc=scn/tw/te/bl/dontworryoldsport

http://hbswk.hbs.edu/item/6903.html

 http://www.forbes.com/sites/realspin/2013/03/05/want-to-reduce-income-inequality-lower-the-barriers-to-talented-immigrants/

 http://repository.library.georgetown.edu/handle/10822/558603