WELFARE AND OUTPUT ENHANCING MORAL HAZARD:DISABILITY BENEFITS AND ENDOGENOUS OCCUPATIONAL CHOICE

One of the most prominent trends in OECD countries over the last 30 years has been the sharp increase in incidence of early retirement, and in particular the permanent take-up of disability benefits. In this paper we construct a theoretical model that shows how occupational choices, in terms of the associated health risks, made by the young can be affected by the expected provision of publicly funded disability benefits in later life. We find that because individuals are risk-averse, they take insufficient risks in the absence of insurance. Disability benefits lead to riskier aggregate behaviour, which in turn increases output and welfare at low levels of benefits, but will lead to excessive risk taking at high benefit levels to the detriment of output and welfare. We also show that the full impact of changes to the generosity of disability benefits in terms of increasing the take-up of such benefits is not immediate, but may take many years to realise because the previous career choices are largely irreversible. This time lag is consistent with the experiences of a number of countries over the last 30 years.