Income Risk, Income Mobility and Welfare

30 Pages Posted: 15 Dec 2012

See all articles by Tom Krebs

Tom Krebs

University of Mannheim

Pravin Krishna

Johns Hopkins University - Paul H. Nitze School of Advanced International Studies (SAIS); Brown University - Department of Economics; National Bureau of Economic Research (NBER)

William F. Maloney

World Bank - Poverty and Economic Management Unit; IZA Institute of Labor Economics; World Bank - Development Research Group (DECRG)

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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.

Keywords: income mobility, labor market risk, social welfare

JEL Classification: J6, E2

Suggested Citation

Krebs, Tom and Krishna, Pravin and Maloney, William F., Income Risk, Income Mobility and Welfare. IZA Discussion Paper No. 7056. Available at SSRN: https://ssrn.com/abstract=2189794

Tom Krebs (Contact Author)

University of Mannheim ( email )

Universitaetsbibliothek Mannheim
Zeitschriftenabteilung
Mannheim, 68131
Germany

Pravin Krishna

Johns Hopkins University - Paul H. Nitze School of Advanced International Studies (SAIS) ( email )

1740 Massachusetts Avenue, NW
Washington, DC 20036-1984
United States

Brown University - Department of Economics ( email )

64 Waterman Street
Providence, RI 02912
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

William F. Maloney

World Bank - Poverty and Economic Management Unit ( email )

1818 H Street NW
Washington, DC 20433
United States
202-473-6340 (Phone)
202-522-0054 (Fax)

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

World Bank - Development Research Group (DECRG)

1818 H. Street, N.W.
MSN3-311
Washington, DC 20433
United States

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