Working Paper: CEPR ID: DP5200
Authors: Jonathan Heathcote; Kjetil Storesletten; Giovanni L. Violante
Abstract: This paper analyses the welfare effects of changes in cross-sectional wage dispersion, using a class of tractable heterogeneous-agent economies. We emphasize a trade-off in the welfare calculation that arises when labour supply is endogenous. On the one hand, as wage uncertainty rises, so does the cost associated with missing insurance markets. On the other hand, greater wage inequality presents opportunities to increase aggregate productivity by concentrating market work among more productive workers. We find that the observed rise in wage dispersion in the United States over the past three decades implies a welfare loss roughly equivalent to a 2.5% decline in lifetime consumption. Assuming Cobb-Douglas preferences, this number is the result of a welfare gain of around 5% from the endogenous increase in productivity coupled with a loss of around 7.5% associated with greater volatility in consumption and leisure.
Keywords: insurance; labour supply; productivity; wage dispersion; welfare
JEL Codes: D31; D58; D91; E21; J22; J31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| rising wage dispersion (J31) | welfare loss (D69) |
| rising wage dispersion (J31) | greater volatility in consumption and leisure (D11) |
| greater volatility in consumption and leisure (D11) | welfare loss (D69) |
| increased productivity (O49) | welfare gain (D69) |
| market incompleteness (D52) | welfare costs (I30) |
| missing insurance markets (G52) | welfare costs (I30) |
| inability to specialize according to comparative advantage (F11) | welfare costs (I30) |