Bonus culture is killing opportunity

Social mobility in the US and the UK has been declining and inequality rising for decades. It is toxic to the economy, and it is a direct result of the bonus culture that has taken over our corporate worlds.

Back in 2004, the Economist published a special report on meritocracy in America. The US has long been considered to be one of the most meritocratic places on earth: most Americans are convinced that hard work and alittle talent can get them anywhere.

The Economist noted that, these days, they are mostly wrong. Even back then, income inequality was rising fast. Between 1979 and 2000, the real income of those in the bottom fifth of US earners rose 6.4% in real terms (pathetic isn't it?) while that of those in the top fifth rose by 70%.

At the same time, the family incomes of those at the top rose by 185%. In 1979, the average income of the top 1% was 133 times that of the bottom 20%. In 2000, it was 189 times. In 2001, the top 1% of households earned 20% of all income: "not since pre-Depression days has the top 1% taken such a big whack."

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Income inequality isn't the same thing as lack of meritocracy and in the main, American dreamers tend to think it isn't such a big deal as long as everyone has a shot at making it to the 1% on merit alone.

The problem? It was beginning to look like they didn't. Several studies were beginning to suggest that social mobility in the US was for the first time declining. A well-known survey done in 1978 found that 23% of adult men born into the lowest fifth of society made it into the top fifth. An update showed that only 10% of the bottom quarter moved into the top quarter. Other studies all showed the same thing: social mobility began to decline in the US in the 1990s.

You won't be remotely surprised to hear that things haven't changed for the better since the Economist review. Last week saw the publication of a piece in the New Republic (a magazine that, as it happens, was founded by Herbert Croly, who via his classic, The Promise of American Life, was one of he inventors of the myth of meritocracy).

On the same subject, it seems that these tendencies are getting increasingly pronounced. But possibly worse in terms of the way Americans view themselves at least US social mobility is now falling behind that of too many other countries.

You are more likely to end up with the same income level of your father in the US than in Denmark, Australia, Norway, Finland, Canada, Sweden, Germany, Spain, France, Japan, New Zealand, Singapore, Switzerland and Pakistan. The only Western countries less mobile than the US are the UK and Italy. Oh dear.

You may wonder why all this is happening. The answer is often said to lie -in part - with education. Schools have been been 'dumbed down' and school competition stifled. Well-off children are compensated for this at home; poorer children find it harder.

At the same time, universities in the US are getting more and more elite: 10-15% of Ivy League students are 'legacies' children of graduates, and in 2004, the median income of a Harvard student's family was $150,000. Also relevant is probably the fact that streamlining and technology was beginning to cut out layers of middle management at big companies, hence making it harder for people to work their way up.

But Timothy Noah, writing in the New Republic, also puts forward the idea that rising income inequality is in itself responsible for falling mobility:

The principal advocates for this viewpoint are Corak and Alan Krueger, a Princeton labour economist who is currently chairman of President Obama's Council of Economic Advisers. For a speech on income inequality delivered at the Center for American Progress on 12 January, Krueger took a scatter diagramme from a 2011 paper by Corak and plugged in more recent data from the OECD.

Corak's diagram plotted income heritability against inequality (as measured by its most common yardstick, the Gini coefficient) and found that the two tended to increase together. Krueger's diagram showed an even tighter fit. Krueger called it the 'Great Gatsby Curve'.

"Countries that had more inequality across households," Krueger said in his speech, "also had more persistence in income from one generation to the next." More income inequality, Krueger concluded, leads to less income mobility.

Projecting from the 'Great Gatsby Curve' - and assuming, perhaps rashly, that present trends will continue - Krueger calculated that, by the time today's children grow up, income heritability will have grown from 47% to 56%.

"In other words," he explained, "the persistence in the advantages and disadvantages of income passed from parents to the children is predicted to rise by about a quarter for the next generation as a result of the rise in inequality that the US has seen in the last twenty-five years. It is hard to look at these figures and not be concerned that rising inequality is jeopardising our tradition of equality of opportunity."

So, income inequality isn't just unattractive in itself. It kills opportunity too. This brings us right back to the main cause of rising income inequality in the West performance related pay or the bonus culture that has taken over the US and UK corporate worlds in the last decade.

I've written here before about the evils it is visiting upon our economies as a whole and the way it creates a toxic bubble-hopping elite. The 'Great Gatsby Curve' just adds to the evidence that we need to do something about it fast.

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.