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Sources of Lifetime Inequality

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Is lifetime inequality mainly due to differences across people established early in life or to differences in luck experienced over the working lifetime? We answer this question within a model that features idiosyncratic shocks to human capital, estimated directly from data, as well as heterogeneity in ability to learn, initial human capital, and initial wealth { features which are chosen to match observed properties of earnings dynamics by cohorts. We find that as of age 20, differences in initial conditions account for more of the variation in lifetime utility, lifetime earnings and lifetime wealth than do differences in shocks received over the lifetime. Among initial conditions, variation in initial human capital is substantially more important than variation in learning ability or initial wealth for determining how an agent fares in life. An increase in an agent's human capital affects expected lifetime utility by raising an agent's expected earnings pro¯le, whereas an increase in learning ability affects expected utility by producing a steeper expected earnings profile. Classification-JEL Codes: E21, D3, D91.

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Paper provided by Georgetown University, Department of Economics in its series Working Papers with number gueconwpa~07-07-04.

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Date of creation: 04 Jul 2007
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Handle: RePEc:geo:guwopa:gueconwpa~07-07-04

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Postal: Georgetown University Department of Economics Washington, DC 20057-1036
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Web page: http://econ.georgetown.edu/

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Postal: Marcia Suss Administrative Officer Georgetown University Department of Economics Washington, DC 20057-1036
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Keywords: Lifetime Inequality; Human Capital; Idiosyncratic Risk;

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