Income Mobility, Income Risk and Welfare

Tom Krebs, Pravin Krishna, William F. Maloney

NBER Working Paper No. 23578
Issued in July 2017
NBER Program(s):Development Economics Program, International Trade and Investment Program, Labor Studies Program, Political Economy Program

This paper presents a framework for the quantitative analysis of individual income dynamics, mobility and welfare, with ex-ante identical individuals facing a stochastic income process and market incompleteness implying that they are unable to insure against persistent shocks to income. We show how the parameters of the income process can be estimated using repeated cross-sectional data with a short panel dimension, and use a simple consumption-saving model for quantitative analysis of mobility and welfare. Our empirical application, using data on individual incomes from Mexico, provides striking results. Most of measured income mobility is driven by measurement error or transitory income shocks and therefore (almost) welfare-neutral. Only a small 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, nevertheless, have economically significant effects on social welfare. Strikingly, roughly half of the mobility that cannot be attributed to measurement error or transitory income shocks is driven by welfare-reducing persistent income shocks. Decomposing mobility into its fundamental components is thus crucial from the standpoint of welfare evaluation.

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Document Object Identifier (DOI): 10.3386/w23578

Published: Tom Krebs & Pravin Krishna & William F Maloney, 2019. "Income Mobility, Income Risk, and Welfare," The World Bank Economic Review, vol 33(2), pages 375-393.

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