How income mobility and income growth explain income inequality trends

Abstract

Proposes a new approach capable of explaining concomitant changes in income inequality and income mobility. Introduction Income mobility and income inequality are two topics that have been the subject of extensive research. Although both topics are clearly related, building a bridge between them remains a challenging task. The aim of this paper is to propose a new approach capable of explaining concomitant changes in income inequality and income mobility. Building on Jenkins and Van Kerm (2006) — hereafter referred to as JVK — the new method establishes a direct link between income-rank mobility, the distribution of winners and losers (i.e. the distributional effect of income growth) and changes in inequality. The application to US data covering the period between 1970 and 2009 illustrates how this approach can bring new insights on the dynamics of income distribution.   The relationship between mobility and inequality can be hard to grasp. As Duval-Hernandezet al. (2014) point out even a Nobel Prize-winning economist may not understand how both inequality and mobility can increase over the same period. Yet, Hernandez et al. (2014, p1) indicate that it is not only possible but also common to find increases in inequality even though “when we follow the same people over time, those who earned the least to begin with gained more in dollars than those who started at the top of the earnings distribution.”   Partly, this apparent contradiction is due to the fact that “the very concept of income mobility is not well-defined” (Fields and Ok 1999, p557). In response a stream of the literature has proposed mobility measures that have a clear relationship with inequality measures. Shorrocks (1978) popularised the idea that mobility can be measured by the extent to which inequality is reduced by an extension of the income-accounting period (see, for example, Bayaz-Ozturk et al. 2014 and Kopczuk et al. 2010 for recent applications of Shorrocks’ approach to the US).   This type of mobility measures bears a clear relationship with inequality measures in that more mobility is always synonymous with less inequality. The trade-off, however, is that they have distanced themselves from the most intuitive definitions of mobility. JVK addresses this limitation in the special case of the widely used Gini index. By drawing on the income tax literature, they show that if mobility is simply defined as income reranking the only remaining factor that explains changes in inequality is the degree to which income growth (i.e., the panel-income changes) is more favour able to the poorer individuals than to the richer individuals.   This paper adopts the same mobility concept as in JVK to propose a new method capable of explaining why and how income growth may reduce inequality or, according to JVK, be ‘pro- poor’. The new method is particularly helpful to shed light on the relationship between income mobility and inequality. We depart from JVK by recognising that over any time period some individuals will see their income increase while others will experience an income loss, and yet other individuals may face no change. It follows that how the income growth process affects inequality depends on the respective size a nd distribution of the income gains and losses. Moreover, distinguishing income gains and losses is relevant from a social welfare perspective as there is evidence that people treat them differently.   One of the major new insights of the application to US data for the 1970/2009 period is that most of the equalising effect of income growth occurs through income gains rather than income losses, a finding that persists even in times of recession. Finally, income mobility shows no clear long-term pattern but it declined during the Great Recession, which is in contrast with previous recessions.   &nbsp