Welfare Effects of Polarization: Occupational Mobility over the Life-cycle

The U.S. labor market has experienced polarization over the past several decades, where employment and wages of middle-class individuals have declined relative to those of low- and high-skill groups. What are the welfare effects of such a structural change? We build an overlapping generations model of individuals who choose consumption, savings, labor supply, and occupations over their life-cycles, and accumulate human capital, as they face uncertainty about labor productivity and longevity as well as the probability of exogenous separation from their current occupations. The model is parameterized to account for life-cycle patterns of occupational distribution and mobility in the early 1980s. We simulate a wage shift as observed in the data during the following decades, investigate individuals' responses, and quantify welfare effects across heterogeneous groups of individuals. Polarization is shown to improve welfare of young individuals that are high-skilled, while it hurts low-skilled individuals across all working ages and especially younger ones. The high-skilled gain is larger for generations entering in later periods, who can fully exploit the rising skill premium. We also evaluate changes in inequality and show how polarization leads to a rise in skill premium, increasing inequality in life-cycle earnings and wealth across individuals.