Spend It While You Can Still Enjoy It: Health, Longevity, Aging, and Consumption in the Life Cycle
- Presenter:
Chair: Willard Manning; Discussant: TBA Tue June 6, 2006 15:30-17:00 Room 226
Simple life-cycle models based on the permanent-income hypothesis predict that individuals will smooth consumption over their lifetimes. However, empirical studies consistently find that consumption levels fall steadily late in life. In this paper, I examine declining health status as one potential factor contributing to this pattern. I estimate a life-cycle model treating health as a form of human capital investment, and predict substantial decreases in consumption after age 50 that are consistent with empirical observations. When health and consumption are complements, decreasing health capital results in falling marginal utility of consumption with age. Thus rational agents will consume at higher levels when they are younger and healthier.
This effect is particularly pronounced among low-income groups, whose health deteriorates more rapidly than the health of their higher-income counterparts. A faster rate of health deterioration results in a steeper decline in marginal utility of consumption late in life among the poor. Additionally, larger investments in health increase longevity in high-income groups relative to low-income individuals, leading to lower rates of consumption and higher rates of savings for the rich across all years. I find that this disparity in longevity, paired with differences in the rate of health deterioration, can largely account for the divergence in life-cycle consumption patterns between the top and bottom income and asset quartiles of the United States population.
The theoretical framework is a dynamic version of Grossman’s seminal 1972 health capital model. While Grossman’s work is frequently cited as a motivation for empirical work in health economics, there have been few if any serious attempts to quantitatively solve the model and closely examine its key implications. In the version of the model presented here, health exogenously deteriorates at an increasing rate with age. To counteract this health deterioration, individuals can invest a portion of their assets into health production each period. If the total health stock falls below some minimal level, the individual dies with certainty. Health investment increases the marginal utility of consumption within each period, and extends the total length of life. Additionally, health is a productive good in the sense that it increases the amount of time an individual can spend in the labor market, thereby augmenting earnings potential. A bi-directional relationship between health and wealth thus emerges: higher wealth induces greater health investment and increased longevity, while better health increases labor market productivity. This feature of the model makes it particularly suited for examining health, wealth, and consumption inequalities.
I estimate the model using data from the Health and Retirement Survey panel, 1992-2002. I construct a health index based on participants’ answers to a series of questions regarding mental health and physical limitations, and find that deteriorating health can account for an annual decline in median consumption levels of about 2 percent after age 50, as compared to an actual drop of around 3 percent. Failing health accounts for a 3 percent annual decline in consumption for individuals with income and assets below the 25th percentile, in contrast to a decrease of only 1 percent per year among individuals with income and assets above the 75th percentile.
