PATH DEPENDENCE

Your financial fate is sealed by the time you turn 25

There are two downbeat facts about the US economy which you hear often lately: incomes are stagnant and inequality is rising. More specifically, the average American man hasn’t gotten a raise since the 1970s (adjusted for inflation) and the gap between high and low earners has been growing wider for decades, too.

New research (pdf) sheds light on these trends in a way previous studies have not. Income changes over your lifetime—typically your income starts low and grows a lot in your 20s and 30s before flattening out in middle age. To understand the drivers of inequality, economists need to consider people’s income over their entire life, not just a snapshot of earnings in a single year.

That has been hard to do, because most detailed income data don’t track people over time. The new paper by a quartet of economists compiled Social Security earnings histories for Americans from the age of 25 to 55. The oldest cohort turned 25 in 1957 and the youngest in 1983.

One of the most striking results of the research is that, in terms of Americans’ average lifetime incomes, inequality hasn’t increased that much over time. But that’s mainly because since the 1950s more women have gone to work and had longer, more lucrative careers. Greater earnings equality between the sexes has meant less overall inequality. If you separate out men and women, there is a significant increase in income inequality within each gender.

The most surprising result, meanwhile, is the apparent root cause of inequality. Almost all income growth takes place in the first 10 years of your career. The chart below shows cumulative pay increases over 10-year periods for several cohorts of people. In each case, almost all income growth, in percentage terms, happens before a worker turns 35.

The data show that pay raises for successive cohorts have grown smaller during the critical early career years. More modest raises when Americans are young is one reason why men’s median lifetime income has barely increased since 1957 and has actually declined since 1967, after adjusting for inflation.

Smaller raises are made even worse when workers start out on lower salaries when they first enter the labor market. Indeed, median income at age 25 declined from $33,300 for the group that was that age in 1967 to $29,000 for the 1983 cohort. What happens during these crucial years can largely explain both lifetime wage stagnation and worsening inequality, the researchers speculate.

Early in life, the researchers identified a bigger dispersion in incomes between the top 10% of earners and everyone else. “Our basic conclusion is that most of the changes from cohort to cohort come from the entry wage [age 25] changing without a very big change in the shape of profiles over the life cycle,” says one of the researchers, University of Minnesota economist Fatih Gevenen. “Clearly, there is some change, but the initial wages change more.”

Why this is happening to younger workers is not entirely clear. Economists often assume inequality is due to differences in skills, yet most people take many years to develop their skills. Thus, the pay disparity among young workers is surprising.

There is evidence that entering the labor market during a recession (pdf) can harm earnings for decades. But the trends can be seen even for groups who start working when the economy is good. There is also evidence that pay varies significantly between firms (pdf) in the same industries with the same sorts of jobs. It could be some 25-year-olds simply work at companies that pay better, and this sets them on a more lucrative path for the rest of their lives.

Whatever the case, it seems that your economic fate may be settled much earlier than you think.

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