Sources of Income Persistence: Evidence from Rural El Salvador

Abstract

This paper uses a unique panel dataset (1995-2001) of rural El Salvador to investigate the main sources of the persistence and variability of incomes. We propose an econometric framework where a general dynamic panel model is validly reduced to a simple linear structure with a dynamic covariance structure, which augments considerably the number of degrees of freedom usually lost in the construction of instruments to estimate standard dynamic panel models. We find that life-cycle incomes are largely explained by the relatively time-invariant productive characteristics of families and their members such as education, public goods and other assets. Controlling for unobserved heterogeneity leaves little room for pure state dependence.