Earnings Dynamics and Intergenerational Transmission of Skill

This paper develops and estimates a two-factor model of intergenerational skill transmission when earnings inequality reflects differences in individual skills and other non-skill shocks. We consider heterogeneity in both initial skills and skill growth rates, allowing variation in skill growth to change over the lifecycle. Using administrative tax data on two linked generations of Canadians covering 37 years, we exploit covariances in log earnings (at different ages) both across and within generations to identify and estimate the intergenerational correlation structure for initial skills and skill growth rates, lifecycle skill growth profiles, and the dynamics of non-skill earnings shocks. We estimate low intergenerational elasticities (IGEs) for earnings in Canada (less than 0.2, even when based on 5-year and 9-year average earnings); however, skill IGEs are typically 2–3 times larger due to considerable (and persistent) variation in earnings conditional on skills. Both earnings and skill IGEs decline substantially for more recent cohorts and are lower for children born to younger fathers. We estimate significant heterogeneity in both initial skills and skill growth rates, showing that intergenerational transmission of these factors explains up to 40% of children’s skill variation. Skills become a more important determinant of earnings over the first part of workers’ careers, while intergenerational transmission of skills becomes less important with age. Although “inherited” initial skills (compared with skill growth) are a more important determinant of children’s skills throughout their lives, parents’ initial skills and skill growth rates are equally important determinants of children’s skills, largely because both strongly influence children’s initial skills. Finally, we study intergenerational mobility for the 35 largest cities in Canada, determining the extent to which considerable differences in earnings and skill IGEs vary with the extent of local heterogeneity in parental skills vs. earnings instability.