Abstract:

We document a robust fact about the working poor: those who are poorer (those with more negative wealth) tend to have higher average wages. Average wages decrease in wealth when wealth is negative, yet they increase for those with positive wealth. This V-shaped pattern with a kink of wages in wealth is robust after controlling for observable characteristics, including age, race, education, and the type of debt — as well as across data sets from many different countries. We propose a theory rooted in occupational sorting with a mean-variance tradeoff: risky jobs pay on average

higher wages. We show that in the presence of financial frictions à la Aiyagari, this leads to the

V-shaped pattern that we document. In the presence of uninsurable wage risk, in addition to precautionary saving, households also engage in precautionary occupational sorting. Those with higher wealth are sufficiently insured against negative outcomes, and they choose riskier jobs. Instead, the poor with negative wealth gamble for resurrection hoping to be fortunate, while defaulting on their interest payments if unfortunate. This leads people who have more negative wealth to choose risker occupations and, as a result, receive higher average wages. We quantify the model and evaluate the welfare implications of different redistributive policies.

For further information please contact: giorgia.bosco@unibocconi.it