The Dynamics of Individual Male Earnings in Great Britain: 1991-1999

In this paper I analyse the dynamic structure of earnings in Great Britain for the period 1991-1999 by decomposing the earnings covariance structure into its permanent and transitory components. Using information on monthly earnings of male full-time employees from the first nine waves of the British Household Panel Study I find that earnings inequality increases over the Nineties. However, earnings mobility may have also increased. That is, for this period earnings persistence falls. Surprisingly, I also find that relative earnings persistence declines over the life cycle, which implies lower mobility for younger cohorts. This evidence is at odds with previous literature on earnings dynamics both for Britain and other OECD countries. Unlike recent studies, I also consider the effects of observed characteristics on the covariance structure of log earnings and find that human capital and job related characteristics account for nearly all persistent earnings differences and that the transitory component is highly persistent. * This paper is a revised version of a chapter from my PhD thesis at the Institute for Social and Economic Research, University of Essex. Main revisions were carried out during several visits to the European Centre for Analysis in the Social Sciences (ECASS) at the Institute for Social and Economic Research, University of Essex supported by the Access to Research Infrastructure action under the EU Improving Human Potential Programme. I would like to thank Stephen Jenkins for his many and valuable comments and discussions and to Lorenzo Cappellari for giving me his Stata programmes and for his helpful comments. My thanks also to Frank Cowell, John Ermisch and Richard Dickens. The usual disclaimer applies. Correspondence to: Universitat Autònoma de Barcelona, Dept. Economia Aplicada, Edifici B, 08193 Bellaterra. Spain. E-mail: [email protected] Non-technical Summary Earnings inequality has markedly increase over the last twenty-five years in Great Britain. This increase in cross sectional inequality is well documented. However we still know very little about the dynamic nature of those individual earnings differences. From a longitudinal perspective, such a widening in earnings dispersion is partly due to individual differences that persist over time and partly due to transitory differences Such distinction is important since permanent and transitory earnings differences have different economic implications. Permanent differences imply little or no earnings mobility and possibly a rigid labour market in where the starting position is crucial for determining individual’s life cycle earnings profile and their position in the earnings distribution over time. Alternatively if cross-section inequality is largely due to short run transitory differences, over time, the burden of inequality can be seen as being shared more equally among individuals. In this paper I analyse some dynamic aspects of earnings inequality in Great Britain for the period 1991-1999 by decomposing the earnings covariance structure into its permanent and transitory components. Using information on monthly earnings of male full-time employees from the first nine waves of the British Household Panel Study I find that earnings inequality increases over the Nineties and follow rather closely the business cycle. The study of the dynamic processes governing such a widening in individual earnings dispersion indicates that both persistent and transitory differences account for increasing earnings inequality. At the beginning of the Nineties, the persistent component plays a somewhat larger rôle. However, in the course of the decade, earnings dispersion becomes more transitory and much less persistent. Thus earnings volatility within the distribution has increased over the Nineties. Surprisingly, I also find that relative earnings persistence declines over the life cycle, which implies lower mobility for younger cohorts. This evidence contrasts with previous literature on earnings dynamics both for Britain and other OECD countries, which have found the transitory and persistent components to play a very similar rôle in accounting for increasing earnings dispersion, and smaller earnings persistency for younger cohorts. To start exploring the causes of the increases in long-run inequality and instability I analyse the residuals from a first-stage regression which nets out the effects of human capital and job related characteristics from log earnings. The results suggest that these covariates account most earnings persistency