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The Evolution of Inequality, Heterogeneity and Uncertainty in Labor Earnings in the U.S. Economy


Flavio Cunha


University of Pennsylvania - Department of Economics

James J. Heckman


University of Chicago - Department of Economics; National Bureau of Economic Research (NBER); American Bar Foundation; Institute for the Study of Labor (IZA); CESifo (Center for Economic Studies and Ifo Institute)

October 1, 2007

PIER Working Paper No. 07-032
IZA Discussion Paper No. 3115

Abstract:     
A large empirical literature documents a rise in wage inequality in the American economy. It is silent on whether the increase in inequality is due to greater heterogeneity in the components of earnings that are predictable by agents or whether it is due to greater uncertainty faced by agents. Applying the methodology of Cunha, Heckman, and Navarro (2005) to data on agents making schooling decisions in different economic environments, we join choice data with earnings data to estimate the fraction of future earnings that is forecastable and how this fraction has changed over time. We find that both predictable and unpredictable components of earnings have increased in recent years. The increase in uncertainty is substantially greater for unskilled workers. For less skilled workers, roughly 60% of the increase in wage variability is due to uncertainty. For more skilled workers, only 8% of the increase in wage variability is due to uncertainty. Roughly 26% of the increase in the variance of returns to schooling is due to increased uncertainty. Using conventional measures of income inequality masks the contribution of rising uncertainty to the rise in the inequality of earnings for less educated groups.

Number of Pages in PDF File: 56

Keywords: wage inequality, uncertainty, sorting, inequality accounting

JEL Classification: D3, J8

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Date posted: October 17, 2007  

Suggested Citation

Cunha, Flavio and Heckman, James J., The Evolution of Inequality, Heterogeneity and Uncertainty in Labor Earnings in the U.S. Economy (October 1, 2007). PIER Working Paper No. 07-032; IZA Discussion Paper No. 3115. Available at SSRN: http://ssrn.com/abstract=1021319 or http://dx.doi.org/10.2139/ssrn.1021319

Contact Information

Flavio Cunha (Contact Author)
University of Pennsylvania - Department of Economics ( email )
3718 Locust Walk
Room 527
Philadelphia, PA 19104
United States
215-898-5652 (Phone)
James J. Heckman
University of Chicago - Department of Economics ( email )
1126 East 59th Street
Chicago, IL 60637
United States
773-702-0634 (Phone)
773-702-8490 (Fax)
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
American Bar Foundation
750 N. Lake Shore Drive
Chicago, IL 60611
United States
Institute for the Study of Labor (IZA)
P.O. Box 7240
Bonn, D-53072
Germany
CESifo (Center for Economic Studies and Ifo Institute)
Poschinger Str. 5
Munich, DE-81679
Germany
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