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Sources of Lifetime Inequality

Mark Thoma directs us to:

Sources of Lifetime Inequality: This NBER Working Paper by Mark Huggett, Gustavo Ventura, and Amir Yaron assesses the relative importance luck and initial conditions in explaining inequality, and asks which type of initial condition, human capital, learning ability, or financial wealth best explains later dispersion in individual earnings. The paper finds that 60% or more of the variation across individuals is due to initial conditions rather than shocks that hit agents during their lifetimes (i.e. good or bad luck), and that among the initial conditions, variation in human capital is the most important factor.

As noted in the conclusions, because the evaluation of initial conditions is conducted at age 20, "pushing back the age at which lifetime inequality is evaluated will raise the issue of the importance of one's family more directly than is pursued here. The importance of one's family and one's environment up to age 20 is not modeled in our work..." But however that turns out, an implication of this work is that we need to do all that we can to ensure that disadvantaged children, all children, are able to build up the human capital they will need to be competitive at age 20 and beyond:

Mark Huggett, Gustavo Ventura, and Amir Yaron (2007), "Sources of Lifetime Inequality" (Cambridge: NBER WP 13224)

We find that as of a real-life age of 20 differences in initial conditions are more important than are shocks received over the remaining lifetime as a source of variation in realized lifetime utility, lifetime earnings and lifetime wealth.[4] We find that between 62 to 73 percent of the variation in lifetime utility and between 60 to 71 percent of the variation in lifetime earnings is due to variation in initial conditions.... Among initial conditions, we find that, as of age 20, variation in initial human capital is substantially more important than variation in either learning ability or initial wealth for how an agent fares in life.... [A] one standard deviation increase in initial wealth increases expected lifetime wealth by 3 to 4 percent. In contrast, a one standard deviation increase in learning ability or initial human capital increases expected lifetime wealth by 9 to 10 percent and 30 to 34 percent, respectively...

Our analysis of lifetime inequality is based upon a parsimonious model. Thus, it is easy to think of initial differences or shocks that are not captured by the model...