Much of observed income mobility is measurement error

Much of the discussion about income inequality and poverty is vacuous if it does not take into account some form of dynamics. Are the poor of today also the poor of tomorrow? If yes, we have a problem, if not, we have much less of a problem. It thus become quite important to measure properly income mobility, how people move from one part of the income distribution to an other. That is easier said than done. One can take two snapshot of the the income distribution, and then calculate some correlations. But there could be measurement error, always a problem, and income changes may be temporary, artificially biasing upwards mobility indicators.

Tom Krebs, Pravin Krishna and William Maloney make significant progress in this measurement by putting some structure to it. For example, a permanent change in income should be reflected in a change in consumption, while a temporary income change does not. Thus, building a consumption-saving model with an income process that has permanent and temporary components, tying this with income data from households in Mexico to calculate income mobility with the new methods and old ones. It turns out that most of the usually measured income mobility comes from measurement error or temporary income. In other words, there is at least in Mexico much less income mobility than we think there is. This is bad news for economies where we know income shocks have a tendency to be temporary, such as the US. The American Dream is farther that you think (previous exhibits I and II).