Forward Thinking and Family Support: Explaining Retirement and Old Age Labor Supply in Indonesia

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Empirical Micro Seminar
University of Pennsylvania

3718 Locust Walk
309 McNeil

Philadelphia, PA

United States

In developed countries, most workers depend on government-based social security systems and private company-based pensions to smooth their consumption. In the developing world, the mechanisms are quite different. In the absence of significant formal institutional support, older individuals rely on their own labor income and on family support in the form of transfer payments, coresidence, and

participation in family businesses. However, the dramatic gains in life expectancy and declines in family size and coresidence that accompany development suggest that these traditional forms of support may break down. In this paper I build and estimate a structural dynamic model of labor supply for older men in Indonesia that incorporates these mechanisms. I use this model to simulate the effects of

demographic change on labor supply and to evaluate the labor supply and welfare effects of a broad public pension reform, which many believe may be a way to address the growing needs of aging populations in developing settings. The estimation results show that families and health play a key role in labor supply choices in old age. When faced with a 50% reduction in family support, simulations show

that older men, especially those in the informal sector, stay in the labor force at ages when they would otherwise exit and experience a substantial decline in welfare.

Simulations also show that a unified defined-contribution pension program for government and private sector workers would provide modest welfare gains at a reasonable cost, but would not offset the potential welfare losses brought by declines in family support. These results highlight the complexities of old age labor supply and pension reform in the context of rapidly developing societies.

For more information, contact Petra Todd.

Douglas McKee

University of Pennsylvania

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