Modern welfare economics suggests that lifetime income is a main determinant of how well individuals fare in economic terms. However, most analyses of income inequality are based on yearly data that might be poorly correlated with lifetime incomes. Typically, these analyses include individuals of different age and educational attainment, whose incomes in a given year may be little representative of their long-term incomes. As sample composition changes over time, it is unclear whether the increase of inequality that is often found in cross-sectional analyses corresponds to a similar evolution of long-term inequality or is simply due to sample changes.
In a recent study, we pinned down the evolution of intra-cohort lifetime earnings inequality in Germany. Starting with the cohort born in 1935, we computed the distribution of lifelong earnings among employees who were born in a same year. Our analysis exploits a rich dataset of the German social security system that includes monthly information about earnings, employment status, sickness and other variables of interest for some 240,000 individuals. Based on this, we built a sample that covers about 80 % of the West German labor force in a typical year.
For the cohorts born between 1935 and 1952, we can compute for each individual his or her lifetime earnings, defined as discounted earnings received between age 17 and age 60. For these cohorts we can thus compare lifetime inequality to annual inequality using the Gini coefficient. We find that the distribution of lifetime earnings for these cohorts is rather compressed, with a Gini coefficient that is less than two thirds of the average value of the Gini coefficients of the distributions of yearly earnings. In other words, yearly earnings show far greater inequality than lifetime earnings. This big difference is caused by the mobility of the individuals in the distribution of yearly earnings during their life cycle – the fact that the same individual may rank low in the distribution of annual earnings in some years and rank high in others. Over a lifetime, the ups and downs offset each other to some extent and make the income distribution less unequal.
But how is lifetime inequality evolving over time? Is it increasing, similarly to what is happening in terms of annual inequality?
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Originally published on OECD Insights on 9 January 2015.