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This paper examines how labor income volatility and social security benefits influence life‐cycle household portfolios. Specifically, it examines the quantity and location of household saving, taking into account liquid financial wealth and annuities, and stocks versus bonds. Higher labor income uncertainty and lower old‐age benefits boost demand for stable income in retirement, but also when young. In addition, a declining equity glide path with age is appropriate for the worker with low income uncertainty but for the high‐income risk worker, equity exposure rises until retirement. We also evaluate how changes in social security benefits influence retirement risk management.

This chapter explores financial asset allocation strategies when human wealth, the expected present discounted value of future labour earnings, is not tradable. Investors should adjust explicit asset holdings to compensate for their implicit holding of human capital and reach the desired allocation of total wealth. Riskless labour income makes human capital equivalent to an implicit holding of safe assets, thereby creating a strong tilt in the financial portfolio towards risky financial assets. Idiosyncratic labour income risk, uncorrelated with financial asset returns, can reduce this tilt but not reverse it; positive correlation between labour income and financial asset returns can reverse the tilt, increasing the demand for safe financial assets. The ability to adjust labour supply makes investors more tolerant of financial risk, because they can respond to poor investment results by increasing work effort, while subsistence needs to act like negative labour income and reduce tolerance for financial risk.

This is the second of five country case studies on income inequality, and shows that income inequality in Venezuela has significantly worsened during the past 27 years; in particular, the worsening has taken the form not of higher inequality among workers, but of higher inequality between those who own and those who do not own capital. Factor shares (shares of factors of production) have moved decisively against labour during the last three decades, resulting in a transfer of approximately 15% of GDP from labour to capital income: the data show an average worker in the late 1990s to be roughly half as well off in terms of income as an average worker in 1970. The chapter examines several possible explanations for the change in income inequality. It has six sections: Introduction; What the data say; Factor Shares, Factor Prices, and Oil Booms—an attempt to explain the evolution of factor shares on the basis of the evolution in human and physical capital accumulation; Other Influences on Income Distribution—an examination of alternative influences on factor shares; Labour's Loss of Power and the Political Economy of Inequality—an in‐depth discussion of the loss of political power by the Venezuelan labour movement and the relationship of this with the main hypothesis presented by the chapter; and Concluding Comments. The main thrust of the explanation offered is that the increase in Venezuela's income inequality can to a great extent be traced back to the decline in the country's physical capital stock and its rigid production processes, although policies such as trade liberalization, contractionary macropolicies, and capital account convertibility have made a far from negligible additional contribution.

For the purpose of hedging risks to standards of living, the logical place to look first would be to markets for claims on total income; but such markets do not exist, and they have apparently never even been proposed. By making it possible to hedge the capital value of a stream of aggregate income, markets in perpetual claims or perpetual futures, long‐term swap markets, or retail analogues of these would facilitate management of the kind of longer‐run income risk that really matters to individuals and organizations; nations or other groupings of people could also use such markets to insure themselves against the prospect of a declining standard of living or the prospect of relative poverty. By hedging such risks, these macro markets would allow the natural tendency for convergence of incomes to reduce inequality of incomes, and might make significant progress toward equalizing wealth across nations, regions, categories of people, and individuals. There could be markets for hedging the risk of fluctuations in aggregate income, national income, or aggregate labour income for each country (or even region) of the world, and these could be divided up in different ways—although since most people's income is labour income, creating markets for claims on total income means for the most part creating markets for claims on labour income. The different sections of the chapter consider possible hedging arrangements in perpetual claims or perpetual futures markets for national incomes (market structures and associated institutions), whether income markets should be in actual or full‐employment income, and various measurement issues associated with incomes (including uncertainty).

This chapter uses a life‐cycle model calibrated to microeconomic US data to examine financial asset allocation strategies of working households saving for retirement. For typical US households with relatively safe labour income streams, risky investments should be extremely attractive when they are young, have modest savings and have many years until retirement; but risky assets should be less attractive later in life, as human wealth declines and financial assets accumulate. Households whose income comes from private businesses, which are exposed to many of the same risks as publicly traded companies, should find risky investments in stocks less attractive at all ages. Households with high‐risk aversion should be cautious investors both because of their high‐risk aversion and their tendency to accumulate greater precautionary savings. Impatient households, on the other hand, accumulate relatively little savings; financial risks are relatively unimportant for them compared to income risks, and thus they can afford to invest more aggressively.

This chapter studies the time consistency problem as it affects tax policy. One example of the time consistency problem is the capital levy. Current governments cannot force future governments to continue their tax policy and the usual scenario in most countries is that there is a ongoing change in tax policies as governments change. This time consistency problem tends to favor income tax over a consumption tax because of the temptation to tax fixed factors like capital at a high rate. However, tax evasion can reverse this scenario. Since it is easier to evade taxes on capital income than taxes on labor income, then it may be optimal to tax labor income at a higher rate than capital income.

This chapter discusses the issue of guessing whether the uncertainty of labour income results should be a reason for higher or lower marginal tax rates. In 1980, Varian was able to examine the question of optimal taxation when consumers are uncertain about income. This current discussion on the subject includes approximations to the optimal linear tax schedule, with an emphasis that the linear income tax is not an optimal policy within the simple model of labour supply.

This is the first of five country case studies on income inequality, and looks at the case of India. Discusses the differences between the approach taken to liberalization in India (the Delhi Consensus) and the standard approach (the Washington Consensus); the Delhi Consensus has emphasized the slow liberalization of trade and very gradual privatization, and has avoided capital account liberalization. This prudent approach has sidestepped major shocks, and the changes in inequality consequent upon these reforms have been relatively modest, although rural inequality has risen at a slower pace than have urban and overall inequality. The rise in inequality is attributed to three factors: a shift in earnings from labour to capital income; the rapid growth of the services sector, particularly the FIRE sector (banking, financial institutions, insurance, and real estate), with a consequent explosion in demand for skilled workers; and a drop in the rate of labour absorption during the reform period, associated with an increase in regional inequality, especially in the incidence of rural poverty. The chapter has five sections: Introduction: Salient Economic Performance Aspects and Recent Policy Reforms—an outline of the economic performance of the Indian economy since the 1950s, with a brief overview of the economic reforms initiated; Trends in Inequality and Poverty in India—an analysis trends in aggregate inequality and poverty, with suggested explanations; Poverty and Inequality at the State Level—an outline of the major characteristics of poverty and inequality at the level of individual Indian states; and Tentative Conclusions.

Many proposals to reform the current social security system would permit the investment of retirement funds in risky assets such as equities. This chapter asks whether there is an important role for international financial assets in a privatized social security system. It shows that international equities provide significant diversification benefits and should be very attractive to retired investors who are currently holding either the real annuity provided by social security or a risky portfolio of domestic assets. The chapter first provides an overview of social security, focusing on the nature of its cash flows. It then explores the consequences of allowing individuals to add risky assets to their retirement portfolios, provides evidence on the behavior of labor income, and analyzes the benefits of a reformed social security system that allows retirees to earn returns on the basis of an optimal investment in the stock market during the retirement period. Finally, the chapter considers the issue of how retirement funds should be invested during the working years.

The direct financial impact of the financial crisis has been to deal a heavy blow to investment-based pensions; many workers lost a substantial portion of their retirement saving. The financial sector implosion produced an economic crisis for the rest of the economy via high unemployment and reduced labor earnings, which reduced household contributions to Social Security and some private pensions. The research asks which types of individuals were most affected by these dual financial and economic shocks, and it also explores how people may react by changing their consumption, saving and investment, work and retirement, and annuitization decisions. The study does so with a realistically calibrated life cycle framework allowing for time-varying investment opportunities and countercyclical risky labor income dynamics. The chapter shows that households near retirement will reduce both short- and long-term consumption, boost work effort, and defer retirement. Younger cohorts will initially reduce their work hours, consumption, saving, and equity exposure; later in life, they will work more, retire later, consume less, invest more in stocks, save more, and reduce their demand for private annuities.

Labor income is an asset, and for young investors the value of labor income usually dominates the rest of their financial holdings. An investor’s mix of assets changes as her labor income evolves over her life cycle, and an investor whose labor income is bond-like should reduce his holdings of equities as retirement approaches. While economic theory suggests that annuities are ideal for retirees, few hold them.

This chapter investigates the different outcomes for individuals born in Mexican states with high exposure to globalization versus individuals born in states with low exposure to globalization between 1990 and 2000. High exposure to globalization does not indicate high exposure to emigration. In Mexico regions, more exposed to globalization have done better in terms of income growth. During Mexico's globalization decade, individuals born in states with high exposure to globalization appear to have done much better than individuals born in states with low exposure to globalization. Thus, they did relatively well in terms of their labor earnings. Labor income in low-exposure states fell relative to high-exposure states by 8–12 percent, and the incidence of wage poverty increased in low-exposure states relative to high-exposure states by 7 percent.

During the past few decades, U.S. households have begun to display increasing financial sophistication and awareness of rates of return on alternative investments. At the same time, the implicit rate of return on contributions to the social security system has declined as the system has matured, and this rate of return is projected to decline further in the twenty-first century in response to unfavorable demographic trends. This chapter examines the demand for financial assets by working investors by solving a calibrated life cycle model of consumption and portfolio choice with labor income uncertainty. Households are assumed to be constrained by restrictions on borrowing and short-selling risky assets. Heterogeneity across demographic groups appears to have important effects on optimal portfolios, suggesting the inadequacy of a “one-size-fits-all” social security system. In a benchmark case, the chapter shows a welfare gain equivalent to 3.7 percent of consumption from the investment of half of retirement wealth into equities, accompanied by a reduction in the social security tax rate to maintain the same average replacement rate of income in retirement.

This chapter examines how minimum wage changes affect wages and earnings, first describing how minimum wages affect the wage distribution. The effect of the minimum wage on the distribution of earnings is not as straightforward as its effect on the distribution of wages, and thus the second goal of the chapter is to provide a more complete description of how the minimum wage influences labor income—both for workers directly affected by the minimum wage and for workers who might be indirectly affected via spillover effects. To this end, it presents evidence on how minimum wages affect workers at different points in the wage distribution. This evidence examines a broader set of margins along which workers at different points in the wage distribution may be affected, including wages, employment, hours, and, ultimately, labor income.

This chapter investigates the responsiveness of labour supply to exogenous changes in wage rates and non-labour income. Because these can either cause a raised or reduced marginal tax rate, the tax reforms of the 1980s can be used as a basis to estimate a proposed model which is consistent with general life cycle behaviour. The chapter derives the conditions on grouping estimators required for the identification and estimation of wage and income elasticities, and relates this to the standard differences in different approaches and considers whether grouping according to tax status itself is likely to provide a reliable guide to labour supply responses. For these purposes the UK tax system has the advantage of simplicity, with most people being either basic rate taxpayers or non-taxpayers because their earnings are below an exogenously given threshold.

This chapter examines the role played by the contract of employment in wage distribution and income inequality, distinguishing between the ordinary entitlement to ‘labour income’ and the finance-derived entitlement to ‘capital income’ linked to share value. The chapter aims to expose the interplay between contract and status in the quantification of income, a differentiation that may be seen as a reinvention of the old divides associated with the master-servant regime. Senior corporate managers, as quasi-partners in the firm, are able to access the residual profit of the firm through bonuses and stock options while most employees are entitled only to a fixed-rate wage. The chapter draws upon insights from corporate law to theorize not only the inequalities between different kinds of employment status but also the way in which those inequalities have been masked by a habit of regarding the contract of employment as a basically homogenous contract-type.

In this chapter we take the final step on the journey we have traversed in the book from the poorest of the poor to reach the richest of the rich—the plutocrats of the book’s title. We review the evidence as to where the plutocrats come from and compare a ‘merit’ view of the sources of their income with the more common ‘rent-seeking’ one. It is the incomes from finance which have been the most contentious and a major a source of dissatisfaction with the highest incomes across the world. We conclude by linking this dissatisfaction with the rise of populism and a new generation of populist politicians.

This chapter examines the saving behavior of households in Germany. The findings reveal extraordinarily stable and sound levels of saving. Germans save regularly, in a manner that is planned, and often with a clearly defined purpose in mind. The result also indicates that precaution and old-age provision are the two most important savings motives in Germany. This chapter also explains that labor income in Germany has less individual variation than labor income in the United States and this reduces the precautionary savings motive.