Incentive Effects of Social Security under an Uncertain Disability Option

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Abstract
This chapter considers methods to estimate retirement incentive effects when the pathways available to an individual are uncertain (to the analyst). It shows that ignoring the uncertainty and endogeneity of the relevant institutional setting (i.e., the available pathways) can severely bias the estimates of incentive effects. It focuses on the disability option that provides particularly strong incentives. It proposes several estimates to bound the “true” incentive effects of social security on early retirement in the face of uncertainty, and it uses an approximate two-stage procedure to tackle the endogeneity problem. The chapter is organized as follows. Section 9.2 provides the institutional background of the German pension system and the early retirement incentives it creates. Section 9.3 introduces the data—a sample of German workers aged fifty-five to seventy drawn from the German Socio-Economic Panel—and describes patterns of retirement, disability, and health in the sample. Section 9.4 presents estimation results for several specifications aimed at correcting for uncertainty and endogeneity of the disability benefit eligibility. Section 9.5 concludes and draws policy recommendations. A commentary is also included at the end of the chapter.

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