Life-cycle Earnings Research Articles

Asset Pricing with Limited Risk Sharing and Heterogeneous Agents

We solve a model with incomplete markets and heterogeneous agents that generates a large equity premium, while simultaneously matching stock market participation and individual asset holdings. The high risk premium is driven by incomplete risk sharing among stockholders, which results from the combination of aggregate uncertainty, borrowing constraints and a (realistically) calibrated life-cycle earnings profile subject to idiosyncratic shocks. We show that it is challenging to simultaneously match asset pricing moments and individual portfolio decisions, while limited participation has a negligible impact on the risk premium, contrary to the results of models where it is imposed exogenously.

Separating uncertainty from heterogeneity in life cycle earnings

This paper develops and applies a method for decomposing cross section variability of earnings into components that are forecastable at the time students decide to go to college (heterogeneity) and components that are unforecastable. About 60% of variability in returns to schooling is forecastable. This has important implications for using measured variability to price risk and predict college attendance.

Life-cycle earnings, cohort size effects and social security: a quantitative exploration

One of the features of the large overlapping generations model pioneered by Auerbach and Kotlikoff (1987) Dynamic Fiscal Policy is that individuals with different experience levels are perfect substitutes in production. This paper replaces this assumption with a labor market characterized by imperfect substitutability between less and more experienced workers. By comparing the quantitative properties of both cases in a calibrated model for Spain, it is found that in the model economy with imperfect substitution, the effects of aging on the financial viability of the pension system are less severe than in the standard model economy with perfect substitution.

Performance, seniority, and wages: formal salary systems and individual earnings profiles

This paper replicates studies by Medoff and Abraham [Quart. J. Eco. 95 1980 703; J. Hum. Res. 16 1981 186] and Flabbi and Ichino [Lab. Eco. 8 2001 359] using personnel data from the Dutch national aircraft manufacturer Fokker. It shows how a formal salary system, as is widely used by large firms, brings about that seniority-wage profiles are largely independent of controls for reported performance in cross-sectional wage regressions even though supervisors' evaluations shape life-cycle earnings profiles. Performance ratings determine how fast a worker climbs the firm's career and wage ladder. The paper also reveals that real wage growth depends on the employer's prosperity, and it demonstrates that formal salary systems cause serial correlation in wage growth and “Green Card” effects.

Separating Uncertainty from Heterogeneity in Life Cycle Earnings

This paper develops and applies a method for decomposing cross section variability of earnings into components that are forecastable at the time students decide to go to college (heterogeneity) and components that are unforecastable. About 60% of variability in returns to schooling is forecastable. This has important implications for using measured variability to price risk and predict college attendance.

Rising Occupational and Industry Mobility in the United States: 1968-1993, Second Version

We analyze the dynamics of worker mobility in the United States over the 1968-1993 period at various levels of occupational and industry aggregation. We find a substantial overall increase in occupational and industry mobility over the period and document the levels and time trends in mobility for various age-education subgroups of the population. To control for measurement error in occupation and industry coding, we develop a method that utilizes the newly released, by the Panel Study of Income Dynamics, Retrospective Occupation-Industry Supplemental Data Files. We emphasize the importance of the findings for understanding a number of issues in macro and labor economics, including changes in wage inequality, productivity, life-cycle earnings profiles, job stability and job security.

Mincer's Overtaking Point and the Life Cycle Earnings Distribution

In 1958 Jacob Mincer pioneered an important approach to understand earnings distribution. In the years since Mincer's seminal work, he as well as his students and colleagues extended the original human capital model, reaching important conclusions about a whole array of observations pertaining to human well-being. This line of research explained why education enhances earnings; why earnings rise at a diminishing rate throughout one's life; why earnings growth is smaller for those anticipating intermittent labor force participation; why men earn more than women; why Whites earn more than Blacks; why occupational distributions differ by gender; why geographic and job mobility predominate among the young; why unemployment is lower among the skilled; and why numerous other labor market phenomena occur. This paper surveys the answers to these and other questions based on research emanating from Mincer's original discovery. In addition, this paper provides new empirical evidence regarding Mincer's concept of the “overtaking age”–a topic not currently well-explored in the literature. In this latter vein, the paper shows that Mincer's original finding of a U-shaped (log) variance of earnings over the life cycle is upheld in recent data, both for the United States as well as at least seven other countries.

Multiple equilibria, fiscal policy, and human capital accumulation

This paper shows that in a three-sector model of endogenous growth with physical and human capital accumulation, taxation policy can generate indeterminacy under plausible parameterizations. The key for this result is that the accumulation of human capital is a non-market activity in which individuals combine their non-working time with intermediate goods that are provided by the market. This assumption is consistent with the microfoundations of human capital accumulation found by the literature on life-cycle earnings.

Mincer's Overtaking Point and the Lifecycle Earnings Distribution

In 1958 Jacob Mincer pioneered an important approach to understand earnings distribution. In the years since Mincer’s seminal work, he as well as his students and colleagues extended the original human capital model, reaching important conclusions about a whole array of observations pertaining to human wellbeing. This line of research explained why education enhances earnings; why earnings rise at a diminishing rate throughout one’s life; why earnings growth is smaller for those anticipating intermittent labor force participation; why men earn more than women; why whites earn more than blacks; why occupational distributions differ by gender; why geographic and job mobility predominate among the young; why unemployment is lower among the skilled; and why numerous other labor market phenomena occur. This paper surveys the answers to these and other questions based on research emanating from Mincer’s original discovery. In addition, this paper provides new empirical evidence regarding Mincer’s concept of the “overtaking age” – a topic not currently well explored in the literature. In this latter vein, the paper shows that Mincer’s original finding of a U-shaped (log) variance of earnings over the life cycle is upheld in recent data, both for the U.S. as well as at least seven other countries.

Performance, Seniority and Wages: Formal Salary Systems and Individual Earnings Profiles

This paper replicates studies by Medoff and Abraham (1980, 1981) and Flabbi and Ichino (2001) using personnel data from the Dutch national aircraft manufacturer Fokker. It shows how a formal salary system, as is widely used by large firms, brings about that seniority-wage profiles are largely independent of controls for reported performance in cross-sectional wage regressions even though supervisors' evaluations shape life-cycle earnings profiles. Performance ratings determine how fast a worker climbs the firm's career and wage ladder. The paper also reveals that real wage growth depends on the employer's prosperity. Furthermore it demonstrates that formal salary systems cause serial correlation in wage growth and 'Green Card' effects.

Evaluating Educational Output: An Estimation Method Based on Cross-Section Data

One of the ways to evaluate educational output rests on its consideration as an investment. A part of the returns can be identified as the differential earnings obtained by individuals with a higher education level. The most common information on the earnings obtained by individuals comes in the form of cross-section data.These must be transformed in order to obtain a life-cycle earnings series from which the effects of education must be isolated. This paper defines a model adapted to the use of cross-section data, which allows us to both rank and respond to the different information problems that successively appear, as well as to propose a classification for the adjustments by which the earnings must be corrected, on the basis of the reasons that justify such adjustments and their order of application.The empirical application of the methodology is directed towards estimating the value of university education in Spain on the basis of the criteria discussed earlier in the paper.

Designing Programs for Heterogeneous Populations: The Value of Covariate Information

Normative judgments embodied in the American legal system mandate that, in certain respects, public policy should treat all members of the population uniformly. Nevertheless, the legal system permits many forms of disparate treatment of the population. The Medicare program provides health-care benefits to persons age 65 and older, but not to younger Americans. The federal welfare-to-work program known as TANF permits states to treat welfare recipients differentially, placing some in job-training and others in basic-skills classes. Judicial sentencing guidelines variously permit or require judges to sentence convicted offenders differentially based on past convictions. Public high schools track students, making class assignments vary with past student achievement. In these and other settings where legal constraints do not preclude disparate treatment, society may choose among many alternative treatment rules. A program could mandate uniform treatment of the population or require that treatment vary in particular ways with observable covariates of the persons treated (e.g., age in the case of Medicare, past convictions in the case of sentencing), or permit agents of society (e.g., judges, welfare case managers, school counselors) to make their own treatment choices, subject to specified constraints. Research on program evaluation can help to inform public policy through efforts to learn the consequences of alternative treatment rules. In particular, evaluation research should seek to characterize how treatment response varies across the population. If we learn that all persons respond to treatment in much the same manner, then the best policy may be one that treats all persons uniformly. However, if we learn that treatment response varies with observable covariates of the persons treated, then society may be able to do better by designing programs in which treatment varies appropriately with these covariates. For example, society may be able to lower recidivism among criminal offenders by sentencing some offenders to prison and others to probation. It may be able to increase the life-cycle earnings of welfare recipients by placing some in job-training and others in basic-skills classes. In these and many other cases, the key to success is to determine which persons should receive which treatments. Regrettably, evaluation research has had little to say about how treatment response varies with observable covariates of the persons treated. A common practice, especially in observational studies, has been to assume that all persons respond to treatment in the same manner. Studies that are sensitive to possible variation in treatment response may report findings by race or gender or age, but they rarely disaggregate the population more finely. As a consequence, policymakers seeking to design programs for heterogeneous populations have to speculate on the consequences of alternative treatment rules. This short article draws on my recent research (Manski, 1997, 2000a, b) to argue that increased attention to observable variation in treatment response would enhance the value of evaluation research.

An empirical analysis of earnings dynamics among men in the PSID: 1968–1989

This study uses data from the Panel Survey of Income Dynamics (PSID) to address a number of questions about life cycle earnings mobility. It develops a dynamic reduced form model of earnings and marital status that is nonstationary over the life cycle. The study reaches several firm conclusions about life cycle earnings mobility. Incorporating non-Gaussian shocks makes it possible to better account for transitions between low and higher earnings states, a heretofore unresolved problem. The non-Gaussian distribution substantially increases estimates of the lifetime return to post-secondary education, and substantially reduces differences in lifetime earnings attributable to race. In a given year, the majority of variance in earnings not accounted for by race, education and age is due to transitory shocks, but over a lifetime the majority is due to unobserved individual heterogeneity. Consequently, low earnings at early ages are strong predictors of low earnings later in life, even conditioning on observed individual characteristics.

LIFETIME INEQUALITY AND TAX PROGRESSIVITY WITH ALTERNATIVE INCOME CONCEPTS

The increased availability of cohort data and use of dynamic microsimulation models means that more attention is now being paid to longer term income concepts. Results are usually reported for only one income concept and a limited number of summary measures, and it is not clear whether results are influenced by the income concept used. This paper uses simulation methods to compare different approaches. For this purpose a very simple lifecycle earnings model was used to generate profiles of pre‐tax incomes. Many comparisons were made using a flexible tax structure and four alternative income concepts. It was found that there was a substantial amount of agreement among the alternative concepts in making pairwise comparisons, with tentative support for the use of present values.

Growth-Rate Heterogeneity and the Covariance Structure of Life-Cycle Earnings

Using U.S. panel data on adult males, I compare the "profile heterogeneity model" of earnings dynamics, in which the earnings/experience profile varies across individuals, to a competing model in which earnings "has a unit root." The latter specification enjoys increasing popularity among researchers. My analysis questions this favor, suggesting the profile heterogeneity model provides a more consistent representation of the data. I also provide new estimates of the variation in earnings growth rates. Previous evidence is from relatively unrepresentative samples. Individuals one standard deviation above the mean enjoy a 20%-30% earnings advantage in just 10 years.

Panel estimates of the gender earnings gap: Individual-specific intercept and individual-specific slope models

This paper develops individual-specific slope (as opposed to individual-specific intercept) models to account for unobserved heterogeneity in estimating male-female wage differentials. Estimates from these models are compared to traditional OLS, as well as to fixed- and random-effects individual- specific intercept approaches. We find unambiguously that unobserved heterogeneity accounts for about 50% of the male-female wage gap, with individual-specific slope models explaining a slightly smaller proportion of the wage gap. Based on inferences from life-cycle earnings models, we conclude that most individual-specific differences manifest themselves early in one's work career, probably even in the type of schooling received.

Inventories and the Short-Run Dynamics of Commodity Prices

The idea that wages rise relative to alternatives as job seniority accumulates is the foundation of the theory of specific human capital, as well as other widely accepted theories of compensation. The fact that persons with longer job tenures typically earn higher wages tends to support these views, yet this evidence ignores the decisions that have brought individuals to the combination of wages, job tenure, and experience that are observed in survey data. Allowing for sources of bias generated by these decisions, this paper uses longitudinal data to estimate a lower bound on the avenge return to job seniority among adult men. I find that 10 years of current job seniority raises the wage of the typical male worker in the U.S. by over 25 percent. This is an estimate of what the typical worker would lose if his job were to end exogenously. Overall, the evidence implies that accumulation of specific capital is an important ingredient of the typical employment relationship, and of life-cycle earnings and productivity as well. Continuation of these relationships has substantial specific value for workers.

Specific Capital, Mobility, and Wages: Wages Rise with Job Seniority

The idea that wages rise relative to alternatives as job seniority accumulates is the foundation of the theory of specific human capital, as well as other widely accepted theories of compensation. The fact that persons with longer job tenures typically earn higher wages tends to support these views, yet this evidence ignores the decisions that have brought individuals to the combination of wages, job tenure, and experience that are observed in survey data. Allowing for sources of bias generated by these decisions, this paper uses longitudinal data to estimate a lower bound on the average return to job seniority among adult men. I find that 10 years of current job seniority raise the wage of the typical male worker in the United States by over 25 percent. This is an estimate of what the typical worker would lose if his job were to end exogenously. Overall, the evidence implies that accumulation of specific capital is an important ingredient of the typical employment relationship and of life cycle earnings and productivity as well. Continuation of these relationships has substantial specific value for workers.

Predicted Future Earnings and Choice of College Major

Using Data from the National Longitudinal Survey of Young Men, the author of this paper examines the relationship between predicted future earnings for five broad fields of study and college students' choice of major. Conditional logit models of major choice that incorporate alternative predicted earnings variables are specified and estimated. The results indicate that, holding family background characteristics constant, individuals are likely to choose majors offering greater streams of future earnings rather than, as some have argued, majors with higher beginning earnings at the time of the choice. It is also found that earnings profiles corrected for self-selection bias have flattened for more recent graduates in business, liberal arts, and education. The life-cycle earnings in these disciplines appear to be more severely depressed than those in science and engineering.

Snapshots versus movies: ‘Lifecycle biases’ and the estimation of intergenerational earnings inheritance

Empirical studies of the intergenerational inheritance of economic status should use observations on complete lifetime status profiles of parents and children to be consistent with underlying theory, but they cannot: only ‘snapshots’ rather than ‘movies’ on status are currently available in samples. Estimates of the degree of intergenerational inheritance may, therefore, be subject to ‘lifecycle biases’. The paper investigates these in the context of a lifecycle earnings model and shows that these biases may be large, that their direction varies, and that correction methods suggested hitherto have questionable reliability. Until more complete data sets become available, researchers should be more temperate in the conclusions they draw.