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The Evolution of Inequality, Heterogeneity and Uncertainty in Labor Earnings in the U.S. Economy

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  • Cunha, Flavio

    ()
    (University of Pennsylvania)

  • Heckman, James J.

    ()
    (University of Chicago)

Abstract

A large empirical literature documents a rise in wage inequality in the American economy. It is silent on whether the increase in inequality is due to greater heterogeneity in the components of earnings that are predictable by agents or whether it is due to greater uncertainty faced by agents. Applying the methodology of Cunha, Heckman, and Navarro (2005) to data on agents making schooling decisions in different economic environments, we join choice data with earnings data to estimate the fraction of future earnings that is forecastable and how this fraction has changed over time. We find that both predictable and unpredictable components of earnings have increased in recent years. The increase in uncertainty is substantially greater for unskilled workers. For less skilled workers, roughly 60% of the increase in wage variability is due to uncertainty. For more skilled workers, only 8% of the increase in wage variability is due to uncertainty. Roughly 26% of the increase in the variance of returns to schooling is due to increased uncertainty. Using conventional measures of income inequality masks the contribution of rising uncertainty to the rise in the inequality of earnings for less educated groups.

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Bibliographic Info

Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 3115.

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Length: 55 pages
Date of creation: Oct 2007
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Handle: RePEc:iza:izadps:dp3115

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Keywords: wage inequality; uncertainty; sorting; inequality accounting;

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  1. James J. Heckman & Paul A. LaFontaine, 2007. "The American High School Graduation Rate: Trends and Levels," NBER Working Papers 13670, National Bureau of Economic Research, Inc.
  2. Blundell, Richard William & Pistaferri, Luigi & Preston, Ian, 2002. "Partial Insurance, Information, and Consumption Dynamics," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3666, C.E.P.R. Discussion Papers.
  3. MaCurdy, Thomas, 2007. "A Practitioner's Approach to Estimating Intertemporal Relationships Using Longitudinal Data: Lessons from Applications in Wage Dynamics," Handbook of Econometrics, Elsevier, in: J.J. Heckman & E.E. Leamer (ed.), Handbook of Econometrics, edition 1, volume 6, chapter 62 Elsevier.
  4. Lars Ljungqvist & Thomas J. Sargent, 2004. "European Unemployment and Turbulence Revisited in a Matching Model," Journal of the European Economic Association, MIT Press, MIT Press, vol. 2(2-3), pages 456-468, 04/05.
  5. MaCurdy, Thomas E., 1982. "The use of time series processes to model the error structure of earnings in a longitudinal data analysis," Journal of Econometrics, Elsevier, Elsevier, vol. 18(1), pages 83-114, January.
  6. Matzkin, Rosa L, 1992. "Nonparametric and Distribution-Free Estimation of the Binary Threshold Crossing and the Binary Choice Models," Econometrica, Econometric Society, Econometric Society, vol. 60(2), pages 239-70, March.
  7. Susanne M. Schennach, 2004. "Estimation of Nonlinear Models with Measurement Error," Econometrica, Econometric Society, Econometric Society, vol. 72(1), pages 33-75, 01.
  8. Sen, Amartya, 2000. "Social justice and the distribution of income," Handbook of Income Distribution, Elsevier, in: A.B. Atkinson & F. Bourguignon (ed.), Handbook of Income Distribution, edition 1, volume 1, chapter 1, pages 59-85 Elsevier.
  9. Carneiro, Pedro & Hansen, Karsten T. & Heckman, James J., 2003. "Estimating Distributions of Treatment Effects with an Application to the Returns to Schooling and Measurement of the Effects of Uncertainty on College Choice," IZA Discussion Papers 767, Institute for the Study of Labor (IZA).
  10. Peter Gottschalk & Robert Moffitt, 1994. "The Growth of Earnings Instability in the U.S. Labor Market," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 25(2), pages 217-272.
  11. Richard Blundell & Ian Preston, 1998. "Consumption Inequality And Income Uncertainty," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 113(2), pages 603-640, May.
  12. Pedro Carneiro & Karsten T. Hansen & James J. Heckman, 2003. "Estimating Distributions of Treatment Effects with an Application to the Returns to Schooling and Measurement of the Effects of Uncertainty on College," NBER Working Papers 9546, National Bureau of Economic Research, Inc.
  13. Milton Friedman & Simon Kuznets, 1954. "Income from Independent Professional Practice," NBER Books, National Bureau of Economic Research, Inc, National Bureau of Economic Research, Inc, number frie54-1.
  14. Abbring, Jaap H. & Heckman, James J., 2007. "Econometric Evaluation of Social Programs, Part III: Distributional Treatment Effects, Dynamic Treatment Effects, Dynamic Discrete Choice, and General Equilibrium Policy Evaluation," Handbook of Econometrics, Elsevier, in: J.J. Heckman & E.E. Leamer (ed.), Handbook of Econometrics, edition 1, volume 6, chapter 72 Elsevier.
  15. Flavin, Marjorie A, 1981. "The Adjustment of Consumption to Changing Expectations about Future Income," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 89(5), pages 974-1009, October.
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Cited by:
  1. James Heckman & Sergio Urzua, 2010. "Comparing IV with structural models: what simple IV can and cannot identify," CeMMAP working papers, Centre for Microdata Methods and Practice, Institute for Fiscal Studies CWP08/10, Centre for Microdata Methods and Practice, Institute for Fiscal Studies.
  2. Steven J. Davis & James A. Kahn, 2008. "Interpreting the Great Moderation: Changes in the Volatility of Economic Activity at the Macro and Micro Levels," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 22(4), pages 155-80, Fall.
  3. Jeffrey Brown & Chichun Fang & Francisco Gomes, 2012. "Risk and Returns to Education," NBER Working Papers 18300, National Bureau of Economic Research, Inc.
  4. Borra, Cristina & Iacovou, Maria & Sevilla, Almudena, 2012. "The Effect of Breastfeeding on Children's Cognitive and Noncognitive Development," IZA Discussion Papers 6697, Institute for the Study of Labor (IZA).
  5. Jonas D. M. Fisher & Martin Gervais, 2011. "Why Has Home Ownership Fallen Among The Young?," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 52(3), pages 883-912, 08.
  6. Athreya, Kartik & Tam, Xuan S. & Young, Eric R., 2009. "Unsecured credit markets are not insurance markets," Journal of Monetary Economics, Elsevier, Elsevier, vol. 56(1), pages 83-103, January.
  7. Steven J. Davis & James A. Kahn, 2007. "Macroeconomic implications of changes in micro volatility," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Nov.
  8. Theloudis, Alexandros, 2011. "From income and consumption inequality to economic welfare inequality: the role of labor supply," MPRA Paper 37517, University Library of Munich, Germany.

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