The Macroeconomic Implications of Rising Wage Inequality in the United States

Abstract

This paper explores the macroeconomic and welfare implications of the sharp rise in U.S. wage inequality . In the data, cross-sectional earnings variation increased substantially more than wage variation, due to a sharp rise in the wage-hours correlation. At the same time, inequality in hours worked and consumption remained roughly constant through time. Using data from the PSID, we decompose the rise in wage inequality into changes in the variance of permanent, persistent and transitory shocks. With the estimated changes in the wage process as the only primitive, we show that a standard calibrated OLG model with incomplete markets can successfully account for all these patterns in cross-sectional U.S. data. Through a set of counter-factual experiments, we assess the role of each component of the wage process for the evolution in the various dimensions of inequality. The model also allows us to investigate the welfare costs of the rise in inequality: we find that the unconditional expected welfare loss is equivalent to a 5 percent decline in lifetime income for the worst-affected cohorts, those entering the labor market in the mid 1980's. Ex post, these costs are widely dispersed across agents, due both to differences in permanent individual attributes and to differences in labor market histories. An extensive sensitivity analysis verifies the robustness of our results to alternative preferences and borrowing limits, and to the inclusion of female labor force participation. JEL Classification Codes: E21, D31.

Top Earners: Cross-Country Facts

“…For example, Heathcote, Storesletten, and Violante (2005) show that the rise in both the variance of log earnings and the variance in log wage rates happens with age in U.S. data by similar amounts. In addition, cross-sectional inequality in log earnings and in log wage rates rises by a similar magnitude as documented by Heathcote, Storesletten, and Violante (2010). Finally, it is widely believed that productivity differences (i.e., earnings per work hour) are key in accounting for the earnings of top earners in U.S. data rather than work-hour differences.…”

“…We do so by briefly discussing two prominent articles that offer a quantitativetheoretical account of the changes in U.S. cross-sectional inequality measures. Heathcote, Storesletten, and Violante (2010) provide a quantitative-theoretical account for the changes in U.S. cross-sectional earnings, consumption, and hours inequality. The key exogenous driving force in their model is changes in transitory and persistent idiosyncratic productivity shocks.…”

“…The articles by Heathcote, Storesletten, and Violante (2010) and Kaymak and Poschke (2016) stress the role of idiosyncratic productivity shocks. Productivity in their models corresponds to wage rates in the data.…”

“…Productivity w takes on six values (z 1 ,…,z 6 ), where z 6 corresponds to an extraordinarily high level of productivity. 12 Heathcote, Storesletten, and Violante (2010) model log productivity as the sum of an age component μ j+1 , a persistent shock η j+1 , and a purely transitory shock ν j+1 . The age component is common to all agents of age j+1, whereas the shock components are agent specific:…”

Insurance and Opportunities: A Welfare Analysis of Labor Market Risk

“…27 The borrowing constraint is set to the "natural" limit (see, for example, Aiyagari, 1994) which ensures that interest payments never exceed earnings, given maximum labor effort. Preferences are Cobb-Douglas and the discount factor is β = 0.97, which implies a final steady state interest rate of 3.05%.…”