A Life Cycle Approach to the Mechanism Connecting Health Inequality and Earnings Inequality

Understanding the sources of earnings inequality and the consequences of earnings risk is important for policy. This paper incorporates the health aspect to this problem and studies its implications for the US economy, which has not so far been done in the strand of the macroeconomics literature that studies and measures sources of inequality and earnings risk. The premise is that earnings and health are closely intertwined for any individual through an economic mechanism. On the one hand, health care is important from the worker's perspective not only because of the value he assigns to his own health and longevity, but also because of the direct effects that health has over the potential productivity of each individual. On the other hand, health care is a private good, so those with higher earnings can afford more health care if desired, than those with lower earnings. The main result of taking into account the health dimension is that income disparities give rise to health disparities, and at the same time, health outcomes shape potential earnings. I build a macroeconomic framework that incorporates these characteristics of health care into a model where workers face risky labor earnings as well as shocks to health, and calibrate it to match moments from US data. This framework will provide insight about the relevance of health as determinant of lifetime earnings risk and persistence of earnings shocks and allow to analyze the effects that different configurations of the health care sector may have on the idiosyncratic productivity risk that workers face through their lifetimes.