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Income Risk, Income Mobility and Welfare

  • Krebs, Tom

    ()

    (University of Mannheim)

  • Krishna, Pravin

    ()

    (Johns Hopkins University)

  • Maloney, William F.

    ()

    (World Bank)

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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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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  2. Jose Cuesta & Hugo Ñopo & Georgina Pizzolitto, 2011. "Using Pseudo‐Panels To Measure Income Mobility In Latin America," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 57(2), pages 224-246, 06.
  3. Baker, Michael & Solon, Gary, 1999. "Earnings Dynamics and Inequality Among Canadian Men, 1976-1992: Evidence from Longitudinal Income Tax Records," Analytical Studies Branch Research Paper Series 1999130e, Statistics Canada, Analytical Studies Branch.
  4. Tom Krebs, 2005. "Job Displacement Risk and the Cost of Business Cycles," 2005 Meeting Papers 188, Society for Economic Dynamics.
  5. Antman, Francisca & McKenzie, David J., 2005. "Earnings mobility and measurement error : a pseudo-panel approach," Policy Research Working Paper Series 3745, The World Bank.
  6. Felix Kubler & Karl Schmedders, 2001. "Incomplete Markets, Transitory Shocks, and Welfare," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(4), pages 747-766, October.
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  8. Fields, Gary S. & Cichello, Paul & Freije, Samuel & Menéndez, Marta & Newhouse, David, 2003. "For Richer or for Poorer ? Evidence from Indonesia, South Africa, Spain, and Venezuela," Economics Papers from University Paris Dauphine 123456789/1560, Paris Dauphine University.
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  10. Peter Gottschalk & Enrico Spolaore, 1998. "On the Evaluation of Economic Mobility," Boston College Working Papers in Economics 407., Boston College Department of Economics.
  11. Geweke, John & Marshall, Robert C & Zarkin, Gary A, 1986. "Mobility Indices in Continuous Time Markov Chains," Econometrica, Econometric Society, vol. 54(6), pages 1407-23, November.
  12. Bénabou, Roland & Ok, Efe A, 1998. "Social Mobility and the Demand for Redistribution: the POUM Hypothesis," CEPR Discussion Papers 1955, C.E.P.R. Discussion Papers.
  13. Chiara Binelli & Orazio Attanasio, 2010. "Mexico in the 1990s: the Main Cross-Sectional Facts," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 13(1), pages 238-264, January.
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  15. Christopher D. Carroll & Andrew A. Samwick, 1995. "The Nature of Precautionary Wealth," NBER Working Papers 5193, National Bureau of Economic Research, Inc.
  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. 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.
  18. tom krebs, 2004. "welfare cost of business cycles when markets are incomplete," Econometric Society 2004 North American Summer Meetings 283, Econometric Society.
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  20. Dang, Hai-Anh & Lanjouw, Peter & Luoto, Jill & McKenzie, David, 2014. "Using repeated cross-sections to explore movements into and out of poverty," Journal of Development Economics, Elsevier, vol. 107(C), pages 112-128.
  21. Dardanoni Valentino, 1993. "Measuring Social Mobility," Journal of Economic Theory, Elsevier, vol. 61(2), pages 372-394, December.
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