Trade Adjustment Costs in Developing Countries: - World Bank ...

Trade Adjustment and Labor Income Risk 173Figure 10.2: Variance in Wage Outcomesrary job loss resulting in a temporary loss of income. Alternately, individualsmoving across sectors may see persistent income losses if the work experiencethey have accumulated in their previous sectors of employment is not valued andthus is not suitably rewarded in their new sector.Figure 10.2 presents a heuristic illustration to clarify the differences betweenthe risk associated with transitory and persistent income changes. Specifically,Figure 10.2 illustrates the difference between transitory and persistent incomeshocks for a group consisting of two identical individuals whose incomes in timeperiod t are both equal to y t . At t+1, they experience shocks to income (somepart transitory and some part persistent) that separate their incomes as indicated.By t+2, the transitory components of the income changes they experienced att+1 expire and incomes for both workers move closer to their initial levels andstay at these levels for the rest of time. In this case, the magnitude of the varianceof the persistent shock experienced at t+1 is measured by the spread in incomesat t+2 (and beyond). The spread in incomes at t+1 measures the sum of thevariance of the transitory shock as well as the permanent shock experienced att+1. Importantly, while in the face of a transitory income shock, workers mayborrow or use their own savings to smooth consumption, this is clearly not feasiblewhen income shocks are persistent. Thus, highly persistent income shockshave a large effect on individual well-being whereas the effect of transitoryshocks is relatively small. Since it is the persistent income shocks that matter themost, it is on these shocks that we focus our attention.The central analytical challenges addressed in this note concern the measurementof income risk faced by workers in a sector by using longitudinal data(where workers are followed over time) and, separately, the extent to which riskfaced by workers in different sectors varies with the sector’s exposure to inter-