Econometrics & Applied Economics Seminar - Xiaodong Fan (Monash University)

Title: Estimation of a Life-Cycle Model with Human Capital, Labor Supply and Retirement

Abstract: We develop and estimate a life-cycle model in which individuals make decisions about consumption, human capital investment, and labor supply. Retirement arises endogenously as part of the labor supply decision. The model allows for both an endogenous wage process through human capital investment (which is typically assumed exogenous in the retirement literature) and an endogenous retirement decision (which is typically assumed exogenous in the human capital literature). We estimate the model using Indirect Inference to match the life-cycle profiles of wages and hours from the SIPP data. The model replicates the main features of the data—in particular the large increase in wages and small increase in labor supply at the beginning of the life-cycle as well as the small decrease in wages but large decrease in labor supply at the end of the life cycle. We also estimate versions of the model in which human capital is completely exogenous and in which human capital is exogenous conditional on work (learning-by-doing). The endogenous human capital model fits the data the best; the learning-by-doing model is able to fit the overall life-cycle pattern; the exogenous model does not. We find that endogenous labor supply is essential for understanding life-cycle human capital investment and life-cycle human capital investment is essential for understanding life-cycle labor supply.