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Income Risk, Income Mobility and Welfare

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  • Krebs, Tom

    ()
    (University of Mannheim)

  • Krishna, Pravin

    ()
    (Johns Hopkins University)

  • Maloney, William F.

    ()
    (World Bank)

Abstract

This paper develops a framework for the quantitative analysis of individual income dynamics, mobility and welfare. Individual income is assumed to follow a stochastic process with two (unobserved) components, an i.i.d. component representing measurement error or transitory income shocks and an AR(1) component representing persistent changes in income. We use a tractable consumption-saving model with labor income risk and incomplete markets to relate income dynamics to consumption and welfare, and derive analytical expressions for income mobility and welfare as a function of the various parameters of the underlying income process. The empirical application of our framework using data on individual incomes from Mexico provides striking results. Much of measured income mobility is driven by measurement error or transitory income shocks and therefore (almost) welfare-neutral. A smaller part of measured income mobility is due to either welfare-reducing income risk or welfare-enhancing catching-up of low-income individuals with high-income individuals, both of which have economically significant effects on social welfare. Decomposing mobility into its fundamental components is thus seen to be crucial from the standpoint of welfare evaluation.

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Bibliographic Info

Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 7056.

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Length: 30 pages
Date of creation: Nov 2012
Date of revision:
Handle: RePEc:iza:izadps:dp7056

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Keywords: income mobility; labor market risk; social welfare;

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  18. Dang, Hai-Anh & Lanjouw, Peter & Luoto, Jill & McKenzie, David, 2011. "Using repeated cross-sections to explore movements in and out of poverty," Policy Research Working Paper Series, The World Bank 5550, The World Bank.
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  21. Tom Krebs, 2005. "Job Displacement Risk and the Cost of Business Cycles," 2005 Meeting Papers, Society for Economic Dynamics 188, Society for Economic Dynamics.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Much of observed income mobility is measurement error
    by Economic Logician in Economic Logic on 2013-03-20 14:19:00

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