Income risk, income mobility and welfare

Tom Krebs, Pravin Krishna and William Maloney

No 6254, Policy Research Working Paper Series from The World Bank

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, component representing measurement error or transitory income shocks and an Autoregressive (AR(1)) component representing persistent changes in income. The analysis uses 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 the 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: Economic Theory&Research; Inequality; Labor Policies; Roads&Highways; Income (search for similar items in EconPapers)
Date: 2012-10-01
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Related works:
Working Paper: Income Risk, Income Mobility and Welfare (2013)
Working Paper: Income Risk, Income Mobility and Welfare (2012)
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