Latent Work Capacity and Retirement Expectations

Understanding how health decline influences retirement decisions is fundamental for the design of targeted policies that encourage working longer. While there is wide agreement on the relevance of age-related health decline for determining labor supply and retirement decisions, the process of how health deterioration affects labor supply remains a black box. This paper explores the match between individuals’ functional abilities and job demands in the national economy using a new methodology to measure work capacity. Specifically, we construct a one-dimensional measure of individuals’ work capacities by comparing an individual’s own ability levels to the levels needed to perform different occupations, using new data containing individuals’ ratings of the same 52 abilities included in the Occupational Information Network (O*NET) database. We find that a one-unit increase in the fraction of jobs for a given education level that an individual can do — our measure of work capacity — is associated with a 15 to 21 percentage point increase in labor force participation, a 10 to 17 percentage point decrease in the percentage of respondents receiving SSDI benefits, a 7 to 10 percentage point increase in the subjective percent chance individuals will work longer, a 9 to 12 percentage point increase in the chance that retired individuals will return to the labor force, and a 17 to 25 percentage point increase in the chance that individuals with disabilities will return to the labor force. The magnitudes of these associations are all economically relevant and exist even when controlling for health status.