Inequality of earnings generally accounts for by far the greatest share of income inequality. Thus, a better understanding of the origins of earnings distribution is of central importance for any public policy which intends to combat economic inequality.

Drawing on and extending the theory of human capital, Research Fellow Robert von Weizsäcker designs a comprehensive life-cycle model of individual earnings in Discussion Paper No. 1014. The approach taken permits an isolated analysis of three interconnected levels of aggregation (intra-cohort distribution, overall distribution, and lifetime distribution) within the same dynamic microeconomic model of educational choice. In this way, interrelated economic, demographic, and fiscal effects on earnings inequality are established. The paper reveals that reallocation reactions of optimizing individuals, combined with population heterogeneity by productive endowments, learning abilities, and working age, can destroy simple relationships between the standard of living, current earnings inequality, lifetime earnings inequality, and public distributional policy.

The study thus provides some possible economic interpretations of empirical findings and identifies several policy conflicts. First, there seems to be an inherent incompatibility of the two social objectives of higher living standards and lower inequality of human wealth: as an example, the paper analyses policy measures for public education. Second, distributional policy decisions made on the basis of current earnings inequality are generally not compatible with those which would have been made on the basis of the distribution of lifetime earnings. Third, earnings inequality is not assigned to single factors per se, but is seen as a result of the individuals' optimization behaviour, which itself depends on numerous forces.

Educational Choice, Lifetime Earnings Inequality, and Conflicts of Public Policy
Robert K von Weizsäcker

Discussion Paper No. 1014, September 1994 (HR)