ECON 665 Assignment 1

Damla Hacibrahimolu 1572791

The Empirical Content of the Roy Model Heckman J.J. and Honor B.E. (1990) Heckman and Honor (1990) develop a nonparametric version of the classical Roy model (no parametric assumption about the distribution of (U1,U2)) with X regressors and test the validity of previously claimed results by relaxing the assumption of normality. The study is motivated by the fact Roy model had been studied and validated for a number of labour market outcomes (union-non-union, womens choice to participate/not participate in labour force, schooling decision, sector choice etc.) yet the robustness of these results are doubtable given the lack of empirical support for normality. The issue was raised by Willis and Rosen (1979) who underlined the fact that joint normality had been used for computational advantages but it is to be admitted that the results are sensitive to such a normality assumptions. Moreover it is highlighted that the underlying distribution of aggregates might not end up being normally distributed. Heckman and Honor (1990) extend the baseline model by deriving the identification restrictions of the lognormal model and its log-concave extension. First, authors build up the standard Roy model and set three cases; either one of the sectors is nonstandard or both sectors are standard (standard in the sense that those who choose a specific sector are the ones who are equipped with the skills resembling to that sector or in other words their sector 1 skills are higher than the population mean). By setting this framework authors strive to study the distributional impacts of changes in relative skill prices given the conditional distribution of skills. Testing the model under log-concavity assumption authors find out that if both sectors are standard an increase in the relative skill price of say sector1, increases log earnings in both sectors by causing positive sorting out. To quote directly from the authors, increasing the skill price in sector 1 attracts those who were previously employed in sector 2 but had comparative advantage in sector 1. The consequence of such market sort out is that given that a sector is standard then more advantaged workers will be attracted to that sector with a rise in relative price, dragging more people to the right tail from the left tail of the distribution. A more formal consequence of such allocation is that in the Roy model, market tends to cause less inequality than what would have otherwise occurred under random assignment. This indeed is a strong conclusion that gives support for the Willis-Rosen (1979) hypothesis of non-hierarchical sorting and comparative advantage. As for another class of distribution, namely the log convexity of skills, the same results had not been validated. Authors conclude that normality is a strong assumption for the Roy model and the results are not robust when studied in a framework of non-normal skill distribution. Authors also study the identification of the non- normal model with additive unobservable characteristics using the variation in agents observable characteristics. They show that the structure of a two sector version of the model is identified if the econometrician observe two excluded variables. It is necessary to observe a variable that affects the income in Sector 1 but not the income of Sector 2, and another variable that affects the income of Sector 2 but not the income of Sector 1. To conclude, Heckman and Honore (1990) strengthens the underlying theoretical framework of Willis and Rosen (1979) by testing the model under non-normality. They also verify the comparative advantage hypothesis and the positive sorting out by their structural model.