A Dynamic Model of Retirement in Indonesia

In developed countries, most workers depend on government-based social security systems and private company-based pensions to smooth their consumption. In the developing world, the mechanisms are quite different. In the absence of significant formal institutional support, older individuals rely on their own labor income and on family support in the form of transfer payments, coresidence, and participation in family businesses. However, the dramatic gains in life expectancy and declines in family size and coresidence that accompany development suggest that these traditional forms of support may break down. In this paper I build and estimate a structural dynamic model of labor supply for older men in Indonesia that incorporates these mechanisms. I use this model to simulate the effects of demographic change on labor supply and to evaluate two possible public pension reforms, which may be necessary to address the growing needs of an aging population in a developing setting. The results show that families and health play a key role in labor supply choices in old age. When faced with declining family support, simulations show that older men stay in the labor force at ages when they would otherwise exit. Moreover, when pension benefits are extended to private sector workers, people switch from unemployment and self-employment into the private sector even when wages are taxed to pay for the pension program. These results highlight the complexities of old age labor supply and pension reform in the context of rapidly developing societies