The Fading American Dream

May 9th, 2017

For decades now, people have embraced the “American Dream” and continue advocating that the next generation should live healthier, richer, and better overall. However, The Equality of Opportunity Project (EOP), a research group focusing on using big data to identify new routes to upward mobility, led by various economic professors from Stanford, Brown, and Harvard, found that it’s becoming increasingly harder for children to earn more than their parents since the 1940s. This is also correlated with the rising income-inequality levels throughout the country, which suggests that upward mobility is becoming more difficult for subsequent generations. This may have a dual effect on the ARM industry:

  • Lower-income individuals should become increasingly more reliant on various forms of credit, potentially prompting higher delinquency levels, which should necessitate specialized third-party collections services.
  • Wealth will slowly become more concentrated among the wealthier sects of the population, potentially hurting the ARM industry since much of their debt may be easily repayable.

Trends in Absolute Income Mobility since 1940

Absolute income mobility measures the fraction of children who earn more than their parents, adjusted for inflation. Raj Chetty, an economics professor from Stanford University and one of the principal investigators for the EOP, and his team researched this topic by comparing datasets covering the 1940 – 1984 birth cohorts, specifically with regard each cohort’s relative income when they reach 30 – meaning that the 1984 cohort data was realized in 2014. Mr. Chetty and his team discovered that the fraction of children earning more than their parents fell from about 92% to just over 50% throughout the nearly 45-year period, as shown in following graph.

Major Factors Behind the Low Mobility Rate

So what factors may be causing the phenomenon? The research team looked further into major factors that influence the mobility rate, and noted a few: 1) lower GDP growth rates; and 2) increasing income inequality. As shown in Figure 2 below, real GDP (RGDP) – GDP adjusted for inflation – growth has increased much more slowly annually, on average, since the 1940s, when the economy experienced massive boons following WWII and, among other things, the influx of women into the workforce. Over time, however, RGDP has staggered and, interestingly, with less volatility. It’s highly expected that this trend will continue into the future, as many experts consider “normal” annual RGDP growth to hover around 2%, which is obviously much lower than at the beginning of our observed period.

Rising income inequality is the other attributed factor negatively impacting the declining absolute income mobility in the US. As shown by Figure 3 below, income inequality, as measured through the Gini Index (if the index increases, then a higher share of the population’s wealth is held by fewer number of people, meaning more income inequality), is becoming increasingly more apparent. As income inequality continues to grow, there should be fewer opportunities for absolute income mobility since much of the GDP growth and wealth is being shared only among the elite and wealthiest, but not throughout the majority.

In short, the sluggish RGDP growth led to slower income growth and increased income-inequality has largely widened the gap, making it more difficult for the majority of workers in the economy to retain much of the nation’s wealth. In other words, because a higher percentage of the sluggish increases in wealth (i.e., slower RGDP growth over time) is funneling toward a smaller portion of population (e.g., increased inequality and the rise of the 1%), children are faced with increased difficulty in earning more than their parents.

Effects on the ARM Industry

If these trends continue, there may be a dual effect on the ARM industry:

  • Low-income earners may be forced to borrow more in order to maintain basic living expenses (i.e., food, rent, healthcare,etc.), thus creating large and potentially unrepayable amounts of credit. These individuals, as they become increasingly more reliant on credit to fund their living expenses, may become less likely to repay their debts, leading to higher delinquencies and defaults throughout the economy. This necessitates outsourcing to ARM businesses, creating more opportunities for specialized third-party debt collectors.
  • High-income earners would hold a greater share of the wealth throughout the economy, which may lead to lower demand for credit, and their debts should be much more easily repayable. This creates a healthier collection process for creditors, reducing the need to outsource to third-party debt collectors, potentially limiting opportunities for the ARM industry.

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