Inequality and the life cycle

Abstract

I structurally estimate an incomplete markets life-cycle model with endogenous labor supply using data on the joint distribution of wages, hours, and consump- tion. The model is successful at matching the evolution of both the first and sec- ond moments of the data over the life cycle. The key challenge for the model is to generate declining inequality in annual hours worked over the first half of the working life, while respecting the constraints imposed by the data on consump- tion and wages. I argue that this is a robust feature of the data on life-cycle labor supply that is strongly at odds with the intratemporal first-order condition for la- bor. Allowing for a realistic degree of involuntary unemployment, coupled with preferences that feature nonseparability in the disutility of the extensive and in- tensive margins of hours worked, allows the model to overcome this challenge. The results imply that labor market frictions are important in jointly account- ing for observed cross-sectional inequality in labor supply and consumption, and may have quantitative relevance for analyses that exploit the intratemporal first- order condition for labor. Keywords. Inequality, life cycle, hours worked, intensive and extensive labor sup- ply, structural estimation, precautionary savings. JEL classification. C13, D21, E21, E24, J22.