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Earnings dynamics of men and women in Finland: permanent inequality versus earnings instability

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Abstract

I decompose the earnings variance of Finnish male and female workers into its permanent and transitory components using the approach of Baker (J Labor Econ,15:338–375, 1997) and Haider (J Labor Econ, 19:799–836, 2001) in the spirit of scientific replication. I find that the increasing earnings inequality of men and women is driven by both the transitory and permanent components of earnings. In addition, I find considerable differences in the earnings dynamics of men and women, that have been largely neglected in previous studies of earnings dynamics. The inequality among men is dominated by the permanent component. Conversely, permanent and transitory components are of comparable magnitudes to women. As a corollary, men experience more stable income paths but display larger permanent earnings differences. Women, on the other hand, face more unstable earnings profiles but show smaller permanent differences in earnings.

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Notes

  1. It should be stressed that income volatility may or may not be equivalent to economic risk. As discussed in Blundell et al. (2008), earnings volatility does not necessarily translate into changes in welfare. Whether changes in earnings volatility have welfare implications depends on whether changes are anticipated and whether individuals are able to insure themselves against instability of earnings.

  2. A notable exception is Ziliak et al. (2011), who report measures of permanent and transitory earnings inequality separately for men and women and for different educational groups, but do not limit their study to employed people.

  3. Gottschalk and Huynh (2010) show that earnings inequality decompositions based on U.S. survey data most likely overstate total inequality due to non-classical measurement errors.

  4. It should be noted, that a similar mechanism might be present for male workers too: a large negative earnings shock may also induce men to drop out of the workforce.

  5. Meghir and Pistaferri (2004) report significant heteroskedasticity in earnings instability using U.S. data, albeit using a different model. Baker and Solon (2003) and Gustavsson (2008) reach similar conclusions using Canadian and Swedish data, respectively.

  6. Since random walk and random growth specifications do not necessarily rule each other out, some researchers (e.g. Baker and Solon 2003 and Ramos 2003) incorporate both into the same model. In my data, this specification either does not converge or results in negative variance estimates. Furthermore, the interpretation of these nested specifications is far from clear.

  7. Identification of earnings instability is made possible only by the off-diagonal elements of the covariance matrix. The underlying intuition is that a high correlation between earnings at t and earnings at \(t-h\) implies a low instability of earnings.

  8. Initial variance parameters have a different interpretation depending on whether earnings trajectories start from the age 26 or at a later age. For a cohort who has been 26 years of age before 1988, the initial variance is a measure of the transitory variance accumulated before 1988, whereas for a cohort who is observed for the first time after 1988, the initial variance is a measure of labor market conditions at the time of labor market entry.

  9. Finland experienced the deepest economic recession experienced in any industrialized country since the 1930s. For details, see, e.g., Gorodnichenko et al. (2009) and Honkapohja and Koskela (1999).

  10. So that the initial variance parameter are only identified by the initial variance in a cohort’s first sample year, \(\lambda _{1988}\) is left unrestricted and \(\lambda _{1989}\) is normalized to 1. Without this restriction, the yearly loadings on the transitory component and the initial variances could not be jointly identified.

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Acknowledgments

I am thankful to the two anonymous referees, Bernd Fitzenberger (the editor), Gero Dolfus, Anssi Kohonen, Heikki Pursiainen, Tatu Westling and the seminar participants at the HECER Econometrics and Computational Economics seminar for various useful comments and to Merja Kiljunen and Marjo Pyy-Martikainen from Statistics Finland for helping me with the data. Financial support from the Kone Foundation and OP Pohjola foundation is gratefully acknowledged.

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  1. University of Helsinki and HECER, Helsinki, Finland

    Otto Kässi

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Correspondence to Otto Kässi.

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Kässi, O. Earnings dynamics of men and women in Finland: permanent inequality versus earnings instability. Empir Econ 46, 451–477 (2014). https://doi.org/10.1007/s00181-013-0693-6

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  • DOI: https://doi.org/10.1007/s00181-013-0693-6

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