Inequality and the Lifecycle

This paper investigates the sources of cross-sectional differences in consumption, labor supply, wealth and welfare over the lifecycle. I document the existence of rich and informative lifecycle patterns in the joint distribution of wages, hours, consumption and wealth. I then estimate a structural model of precautionary savings with endogenous labor supply and uninsurable wage risk in an attempt to assess the ability of the standard incomplete markets model to simultaneously account for the various dimensions of lifecycle inequality. I find that in many dimensions the model provides a coherent explanation. However, the combination of certain features of the data provides an inherent challenge for this class of models. Structural estimates of parameter values are obtained using Monte-Carlo Markov Chain techniques. These are then used to decompose inequality at different points in the lifecycle into differences in preferences, differences in initial wealth endowments, differences in fixed labor productivity and the accumulated effects of shocks realized after entry to the labor market. I find that around 40% of the cross-sectional differences in lifetime welfare are due to fixed skills and around 60% are due to lifecycle productivity shocks. Differences in financial wealth endowments, however, account for almost none of the inequality in lifetime welfare.