Working Papers of the ESRC Research Centre on Micro-Social Change
February 1, 1999
In this paper I decompose the monthly earnings of male full-time employees into their permanent and transitory components, using the British Household Panel Study for the period 1991-95. Cross-section evidence points at a positive message: the increasing earnings inequality trend of the 1980s is interrupted. Notwithstanding this, I find that a substantial proportion of individual earnings differences at a point in time have a permanent character. Changes in total earnings variance, however, are mostly accounted for by changes in the transitory component, which comprise the effects of random shocks which persist longer than one period but that depreciate very quickly. Unlike recent studies on the covariance structure of earnings, I also consider the effects of observed characteristics on the covariance structure of log earnings. Human capital related observables account for some of the permanent component of log earnings, whereas more job related variables also impinge on transitory differences. Finally, the implications of such a structure, which contemplates individual heterogeneity and serial correlation, are illustrated for the case of low earnings probabilities by cohorts. If the low earnings threshold is set at half the median earnings, single period probabilities are higher for the youngest cohort (those born after 1960) and oldest cohort (those born before 1940); joint probabilities for a pair of consecutive periods are fifteen times larger than the product of single year probabilities for those born between 1941-60, and three and six times larger for the youngest and oldest cohorts respectively. The probability of low earnings in a given period for an individual born between 1941-60 chosen at random is fifteen times higher if he was in the low earnings state in the previous period than if he was not.