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Mr. Tom Krebs, Mr. Pravin Krishna, and Mr. William Maloney
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.
Mr. Tom Krebs, Mr. Pravin Krishna, and Mr. William Maloney

I. Introduction Individual income dynamics characterize society in important ways. The degree to which individuals move across different sections of the income distribution is often summarized by one parameter, income mobility. Indeed, income mobility is probably the single most important indicator of individual income dynamics used in public policy discussions. 2 Income mobility is important as it informs us about the opportunities afforded by society to escape one’s origins. 3 At the same time, mobility may also be driven by variability in incomes

Mr. Prakash Loungani

HOW MUCH income mobility is there in today’s economies? A high degree of mobility would imply, in the words of Columbia University’s Jagdish Bhagwati, that capitalism’s “inequalities then become tolerable, not because the rich deny themselves self-indulgence but because the poor fancy that these prizes may come to them someday too.” Much of the evidence on income mobility is for the United States. In the State of Working America , researchers at the Economic Policy Institute conclude that while the U.S. evidence “does not reveal a great deal of income

Ms. Irina Dolinskaya and Ms. Irina Tytell

divergence, the resulting income mobility pattern is related to variables that reflect inherited industrial structure and regional fiscal position, using the ordered logit technique. The study is based on an extensive dataset covering 89 regions comprising the Russian Federation during the period from 1991 to 1997. 13 The paper is organized as follows: Section II describes the data used, Section III reviews the dynamics of the income distribution across Russian regions, Section IV analyzes the evolution of the distribution using the transition matrix methodology