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Income Risk, Income Mobility and Welfare

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Author Info

  • 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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References

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  1. John Heaton & Deborah Lucas, 1993. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," NBER Working Papers 4249, National Bureau of Economic Research, Inc.
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  8. Michael Baker & Gary Solon, 2003. "Earnings Dynamics and Inequality among Canadian Men, 1976-1992: Evidence from Longitudinal Income Tax Records," Journal of Labor Economics, University of Chicago Press, vol. 21(2), pages 267-288, April.
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  15. Cuesta, Jose & Nopo, Hugo & Pizzolitto, Georgina, 2011. "Using Pseudo-Panels to Measure Income Mobility in Latin America," IZA Discussion Papers 5449, Institute for the Study of Labor (IZA).
  16. Cruces, Guillermo & Lanjouw, Peter & Lucchetti, Leonardo & Perova, Elizaveta & Vakis, Renos & Viollaz, Mariana, 2011. "Intra-generational mobility and repeated cross-sections : a three-country validation exercise," Policy Research Working Paper Series 5916, The World Bank.
  17. Antman, Francisca & McKenzie, David J., 2005. "Earnings mobility and measurement error : a pseudo-panel approach," Policy Research Working Paper Series 3745, The World Bank.
  18. Dardanoni Valentino, 1993. "Measuring Social Mobility," Journal of Economic Theory, Elsevier, vol. 61(2), pages 372-394, December.
  19. Gallant, A. Ronald, 1975. "Seemingly unrelated nonlinear regressions," Journal of Econometrics, Elsevier, vol. 3(1), pages 35-50, February.
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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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