The retirement-consumption puzzle and involuntary early retirement: Evidence from the British Household Panel Survey. Sarah Smith

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1 THE CENTRE FOR MARKET AND PUBLIC ORGANISATION The Cenre for Marke and Public Organisaion, a Research Cenre based a he Universiy of Brisol, was esablished in The principal aim of he CMPO is o develop undersanding of he design of aciviies wihin he public secor, on he boundary of he sae and wihin recenly privaised eniies wih he objecive of developing research in, and assessing and informing policy oward, hese aciviies. Cenre for Marke and Public Organisaion Universiy of Brisol Deparmen of Economics Mary Paley Building 12 Priory Road Brisol BS8 1TN Tel: (0117) Fax: (0117) cmpo-office@brisol.ac.uk The reiremen-consumpion puzzle and involunary early reiremen: Evidence from he Briish Household Panel Survey Sarah Smih January 2006 Working Paper No. 06/138 ISSN X

2 CMPO Working Paper Series No. 06/138 The reiremen-consumpion puzzle and involunary early reiremen: Evidence from he Briish Household Panel Survey 1 Sarah Smih CMPO, Universiy of Brisol and Insiue for Fiscal Sudies January 2006 Absrac This paper uses daa from he Briish Household Panel Survey (BHPS) o shed furher ligh on he fall in consumpion a reiremen (he reiremen-consumpion puzzle ). Comparing food spending of men reiring involunarily early (hrough ill healh or redundancy) wih spending of men who reire volunarily, i finds a significan fall in spending only for hose who reire involunarily. This is consisen wih he observed fall in spending being linked o a negaive wealh shock for some reirees. Keywords: Reiremen, life-cycle model of consumpion and saving JEL Classificaion: D91, J26 Acknowledgemens I would like o hank Richard Blundell and James Banks for heir advice and help. The paper was much improved afer commens from an anonymous referee and from paricipans a an IFS seminar and a he Royal Economic Sociey Conference and he BHPS Users Conference. Daa from he BHPS were made available by he Economic and Social Research Council. I ake full responsibiliy for any remaining errors. Address for Correspondence CMPO Deparmen of Economics Universiy of Brisol 12 Priory Road Brisol BS8 1TN Sarah.smih@brisol.ac.uk 1 This paper is forhcoming in he Economic Journal CMPO is joinly funded by he Leverhulme Trus and he ESRC

3 A number of sudies (see Hamermesh (1984), Banks e al (1998), Bernheim e al (2001), Ameriks e al (2002), Hurd and Rohwedder (2003), Miniaci e al (2003), Haider and Sephens (2004), Aguiar and Hurs (2004) and Blau (2004)) have found ha average consumpion falls significanly a reiremen, even allowing for obvious work-relaed spending iems. This fall, common across a number of counries (US, UK and Ialy), across differen ime periods and across differen measures of spending, is a odds wih he predicions of a simplified life-cycle model of consumpion and has become known as he reiremen-consumpion puzzle. Looking a consumpion a reiremen is imporan for a leas wo reasons. Firs, i can give insighs ino how well off people are in reiremen, compared o when hey are working. Paricularly if reired people hold subsanial levels of (non-annuiised) wealh which hey use o finance consumpion, looking direcly a spending may provide a beer measure of how well off people are han income replacemen raes. Secondly, i may provide one way of assessing wheher people have saved enough for heir reiremen, an issue aracing increasing policy ineres in he UK given he governmen s deliberae aemp o shif more of he burden of pension provision from he sae o individuals. Looking a wha happens o people s spending in reiremen is one possible way o gauge he adequacy of heir saving if people have o reduce spending, conrary o he predicions of a forward-looking life-cycle model of consumpion and saving, i may sugges ha hey have no saved enough. Bu, before drawing policy conclusions, i is imporan o ry o undersand why he drop in spending has occurred wheher because of irraional financial planning prior o reiremen (Bernheim e al (2001)), or earlier han expeced reiremen (Haider and Sephens (2004)) and/or lower han expeced pension income, or somehing else. Indeed, a fall in spending may be opimal given increased leisure ime (Hurd and Rohwedder (2003), Aguiar and Hurs (2004)). This paper revisis he reiremen-consumpion puzzle and looks a wha happens o spending on food a reiremen using panel daa drawn from he Briish Household Panel Survey (BHPS). Consisen wih he earlier findings for he UK (Banks e al (1998)), here is evidence of a fall in mean (and median) spending on food around he ime of reiremen (see Figure 1). 2

4 Figure 1: Food spending a reiremen Real weekly spending on food Years before/afer reiremen mean food spending median food spending This paper explores one hypohesis suggesed by Banks e al (1998) as o wha migh explain he drop in consumpion ha, a leas for some people, reiremen is accompanied by a negaive wealh shock ha causes hem o reduce heir spending. In paricular, he paper looks a wheher he fall in consumpion may be caused by unanicipaed early reiremen. I does his by caegorizing reiremens as volunary or involunary, where involunary reiremens occur earlier han anicipaed as a resul of ill-healh or redundancy, 2 and hen comparing wha happens o spending across he wo groups. Involunary reiremen is more likely o be associaed wih a negaive wealh shock because of los earnings and/or pension wealh and if spending falls only among his group, i would sugges ha he reiremen-consumpion puzzle migh be a leas parly resolved in erms of a negaive wealh shock. The res of he paper is as follows. The nex secion summarizes previous, relaed sudies on he reiremen-consumpion puzzle. Secion 2 discusses he daa and he definiions of volunary and involunary reiremens and presens some simple descripive saisics, while secion 3 presens he resuls of fixed-effecs regressions comparing spending a reiremen for volunary and involunary reirees. Secion 4 offers some conclusions. 2 Of course, redundancy does no necessarily lead o reiremen (permanen labour marke exi), bu he wage cu someone would have o ake in geing anoher job may be enough o make hem sop working alogeher. 3

5 1. The puzzle and possible resoluions The fac ha observed consumpion falls a reiremen is a challenge o he simple, one-consumpion-good life cycle model. In is simples form, wih uiliy dependen only on consumpion, no uncerainy and assuming ha marginal uiliy is coninuous and declining in consumpion, he maximisaion of lifeime uiliy implies ha he marginal uiliy of consumpion, and consumpion iself, should be smoohed. In his case, falling consumpion a reiremen would imply irraional behaviour by consumers. This is he conclusion reached by Bernheim e al (2001) who argue ha he evidence of a fall in spending a reiremen poins o people using rules of humb, raher han forward-looking opimising behaviour, o deermine reiremen saving. One possible explanaion is ha he sudies capure a fall in spending a reiremen, which is no he same as a fall in uiliy-producing consumpion a reiremen. Households may sock up on durables immediaely prior o reiremen and enjoy a higher flow of services from durables afer reiremen; hus while heir observed spending may fall, heir overall consumpion remains he same. However, Miniaci e al (2003) find no evidence of pre-reiremen socking up of durables. Anoher possible explanaion is ha here is a necessary level of (non-uiliy-producing) spending associaed wih working, for example he cos of buying suis and ravelling o work, ha sops when people reire. Again, his would imply ha, while observed spending falls, (uiliy-producing) consumpion may be smoohed over reiremen. This effec will be reinforced o he exen ha he spending of he reired on cerain iems is subsidised (ranspor and prescripion charges in he UK, healh in he US). However, Banks e al (1998) ake ou obvious work-relaed spending iems from oal spending and look a sub-componens of spending and sill find evidence of a fall a reiremen. Two possible exensions o he simple life cycle model, however, would be consisen wih a fall in spending a reiremen. One possibiliy is ha spending falls as a resul of he big increase in leisure on reiremen. 3 Spending would fall eiher, if consumpion and leisure are subsiues in a household uiliy funcion, or if ime is a subsiue for spending in a household producion funcion o generae consumpion. Aguiar and Hurs (2004) use deailed informaion on food inake and ime use in he US o show ha, despie a fall in 3 There is clearly an issue abou wheher such a discree change is opimal from he individual s poin of view given diminishing marginal reurns o leisure. There are possible reasons why individuals may no wan o reduce heir hours gradually, including fixed coss associaed wih working and/or economies of scale in convering ime ino uiliy-producing leisure. More likely, hey may face consrains in heir choice of he number of hours o work as a resul of he fixed coss of employmen o he employer and, for people wih a defined benefi occupaional pension in he UK, curren legal resricions on drawing any pension income while sill working for he same employer. 4

6 spending on food, nuriional conen and qualiy are mainained and ha more ime is spen on shopping and food preparaion. As evidence in suppor of he leisure-subsiuion hypohesis, Hurd and Rohwedder (2003) show ha mos people anicipae ha spending will fall a reiremen and, if anyhing, ha he anicipaed decline is greaer han he fall in spending ha acually occurred among (a differen group of) hose who had already reired (20% compared o 12% among married couples, for example). Ameriks e al (2002) also find ha many people expec o spend less in reiremen. However, his evidence, while ineresing, is no conclusive abou he mechanism ha causes acual spending o fall (people may anicipae ha spending will fall if hey are following a simple rule of humb, for example). Hurd and Rohwedder s evidence is less convincing for being based on cross-secion analysis and here are imporan differences beween sub-groups. For example, anicipaed declines in spending a reiremen vary lile wih income, wealh and healh saus, bu he acual falls in spending are far greaer for hose who, pos-reiremen, are in he boom income and wealh quariles and self-repor poor healh. Using daa from he earlier Reiremen Hisory Survey, which does link expeced and acual changes in spending for he same people, Haider and Sephens (2003) show here is lile correlaion beween he wo he fall in spending ha occurs in reiremen is broadly he same whaever people s prior expecaions. A second possible explanaion for he fall in consumpion is ha reiremen may be associaed wih a negaive shock o wealh. If reiremen is earlier han anicipaed, for example, here may be los earnings and/or pension accrual. This is quie plausible Disney and Tanner (1999), for example, show ha more people reire earlier han expeced han laer. Of course, earlier han expeced reiremen may follow from a posiive wealh shock, bu Tanner (1998) and Marmo e al (2004) find many people ciing ill healh and compulsory early redundancy as he main reason for early reiremen. Blau (2004) calibraes a model of reiremen showing ha uncerainy over he iming of reiremen will generae a fall in spending if reiremen is a discree even. Banks e al (1998) and Bernheim e al (2001) explore wheher spending falls when reiremen is anicipaed by insrumening reiremen wih lagged reiremen and age respecively. In boh cases, he drop is smaller when reiremen is anicipaed (alhough no eliminaed alogeher). For he US, Haider and Sephens (2003) reach a similar conclusion using subjecive reiremen expecaions as he insrumen. This paper adops a differen approach o esing he hypohesis ha he fall in spending may be linked o unanicipaed early reiremen, ha is o compare he spending of volunary and involunary reirees. The nex secion discusses in deail how hese wo groups are defined. 5

7 2. The daa The daa in his paper are drawn from he firs eleven waves of he BHPS. This panel daase has been collecing informaion on he same sample of approximaely 10,000 individuals each year since The analysis focuses on a cohor of men aged in he firs year of he survey, a oal sample of around 2,000. Since he BHPS covers all ages, i has a smaller number of individuals in he relevan age range for sudying reiremen han, for example, he US Healh and Reiremen Survey and he new English Longiudinal Survey of Ageing. Neverheless, here is a reasonablesized sample of more han 500 reiremens 4 and a wide number of variables, including informaion on spending, well-being, income and healh. As discussed furher below, he variables are ofen no ideal (he informaion on spending, for example is very limied compared o he Family Expendiure Survey). However, given ha he main purpose of his paper is o compare behaviour across differen groups, his is arguably less of a problem han i oherwise would be. Volunary/ involunary reiremen To sar wih, he definiion of reiremen used is he firs period ha someone is boh no working and repors heir employmen saus as reired. 5 As oher sudies have found (Tanner (1998), Marmo (2004)), he experience of reiremen is very varied. Firs, here is a wide spread of reiremen ages (shown in Figure 2) wih around 60% of men reiring before he sae pension age of 65, 20% a age 65 and 20% afer age See Bardasi e al (2000) for a sudy of incomes a reiremen using he BHPS 5 In he BHPS someone can no be simulaneously working and reired since hese are muually exclusive caegories. In oher surveys, such as he UK Reiremen Survey and ELSA, reiremen saus is asked independenly of employmen saus, so ha someone can be reired and working. 6

8 Figure 2: Disribuion of reiremen ages Proporion of reiremens Age of reiremen Figure 3: Employmen saus prior o reiremen 100% 80% 60% 40% LT sick, disabled Unemployed Employed Self-employed 20% 0% Years before reiremen There is also a variey of roues ino reiremen. The majoriy of men reire from (usually full-ime) employmen, bu as shown in Figure 3, around 40% of men move ino reiremen from anoher (self-assessed) non-working sae, usually unemployed or long-erm sick/disabled, and here is an increasing proporion of men in hese nonworking, non-reired saes in he run-up o reiremen. 7

9 Finally, among men who reire before he sae pension age, here is a wide range of differen reasons given for having done so. In Wave 11 of he BHPS, as par of a special reiremen module, respondens are asked o say why hey reired earlier han hey could have done. The answers, summarized, in Table 1, broadly reflec varying degrees of volunarism offered reasonable financial erms and o enjoy life while young and fi sugges ha early reiremen was he individual s own volunary choice, while own ill-healh and redundan, dismissed and no choice sugges ha he individual reired earlier han hey may have anicipaed and/or waned o. Of course, hese reasons may reflec an elemen of pos-hoc raionalisaion and/or recall error. Bu, as in earlier work (Tanner (1998)) here is a srong link beween he roue ino reiremen and he reason given. Those who repor ill-healh or redundancy as he main reason for early reiremen are more likely o ener reiremen hrough anoher non-working sae, while hose who ener reiremen sraigh from employmen are more likely o repor reasonable financial erms or enjoying life while young and fi. Table 1: The (main) reason for early reiremen All Reired from work Reired from non-work Own ill-healh 23.3% 15.0% 48.5% Redundan/ dismissed/ no choice 18.1% 15.0% 27.3% Offered reasonable financial erms 31.6% 36.0% 18.2% To enjoy life while young and fi 15.8% 20.0% 3.0% Oher 11.2% 14.0% 3.0% Toal 100% 100% 100% This suggess ha here are (a leas) wo disinc experiences of reiremen. For he majoriy of people, reiremen appears o be, broadly, volunary. In hese cases, people ener reiremen sraigh from employmen and, if hey reire early, do so because hey are offered reasonable financial erms or o enjoy life while young and fi. For some, however, here is evidence ha reiremen is involunary. They are more likely o cie ill-healh or redundancy as he main reason for reiring early and o ener reiremen from employmen via anoher non-working sae (suggesing ha a he ime hey leave work, hey may no anicipae ha heir exi is going o be permanen). For he reiremen-consumpion puzzle, his disincion is poenially imporan because hose who reire involunarily, earlier han hey anicipaed or waned, are more likely o experience a negaive shock o heir wealh hrough los earnings or pension accrual ha may cause hem o reduce spending in reiremen. 8

10 The issue explored in his paper is wheher here are observable differences in spending a reiremen for he wo ypes of reirees ha would suppor his hypohesis. For he purpose of his analysis, he wo ypes of reiremen volunary and involunary are defined in he following way (see Appendix for furher deails): Volunary reirees reire direcly from working, are observed o work for a leas wo consecuive periods prior o reiring and are no observed o reener employmen afer reiremen (= 226 reiremens). Involunary reirees reire from a non-work employmen sae (ypically unemployed or long-erm sick/ disabled), are observed working prior o becoming unemployed/sick and are no observed o re-ener employmen afer reporing hemselves as reired (= 57 reiremens). In hese cases, he dae of reiremen is redefined o be when he person lef work raher han when hey firs self-repored hemselves as reired. The number of reiremens ha can be allocaed o one of hese wo groups (283) is smaller han he oal number of reiremens observed in he BHPS (around 500). In he majoriy of cases his is because he person is never observed in work prior o reiremen. 6 In oher cases, i is because he person re-eners employmen afer declaring hemselves o be reired. The assignmen of individuals as volunary or involunary reirees ineviably has a degree of arbirariness for example he requiremen ha individuals are observed no o re-ener work will be more resricive for hose who are observed o reire earlier in he survey period. 7 Secion 3 below repors regression resuls using an alernaive definiion of being ou of work for wo consecuive periods. Anoher possible alernaive would be o use he reasons given for early reiremen o caegorize people as volunary and involunary reirees. However, since hese are available only in wave 11, his would end o reduce he sample size furher and, as saed above, he responses may be subjec o pos-hoc raionalisaion and/or recall error. The characerisics of he wo groups of reirees are fairly disinc, as shown in he able below. Volunary reirees end o have higher occupaions and educaional qualificaions and are more likely o have an occupaional pension. Involunary reirees are more likely o repor ha heir healh limis heir daily aciviies. 8 This raises he possibiliy ha any observed differences in spending beween he wo 6 This is imporan since reiremen for involunary reirees is re-defined as when hey leave work raher han when hey move from non-work o reired. 7 Also, he employmen saes are hose a he ime of inerview, whereas some individuals may change employmen sae beween inerviews. 8 This variable is no available in wave 9 of he BHPS and mus be impued. See Secion 3 for deails. 9

11 groups may be aribuable o he differen characerisics of he groups raher han he naure of heir reiremen and his is explored furher in he regressions below. Table 2: Characerisics of volunary and involunary reirees Volunary Reirees Involunary Reirees Professional/ managerial occupaion 27.9% 17.9% Manual occupaion 52.7% 64.3% Occupaional pension 59.3% 56.1% Worked in he public secor 76.6% 80.7% Higher educaional qualificaion 30.9% 17.9% No educaional qualificaion 31.8% 44.6% Healh limis daily aciviies (in reiremen) 20.3% 42.3% N Measures of spending in he BHPS The BHPS only collecs informaion on food spending in all waves. Clearly i would be preferable o have a fuller measure of household spending, bu as a necessary good wih a small income elasiciy, food provides quie a srong es of consumpion smoohing; if households do no smooh spending on food, hey are unlikely o smooh oher forms of spending (alhough if food spending is smoohed, i can no be rejeced ha oal spending falls). Respondens are asked approximaely how much does your household usually spend each week in oal on food and groceries. In he firs wave, hey are asked o give a coninuous answer; in subsequen waves, hey are asked o say in which band (ou of 12) heir weekly food spending lies. They are old o include all food, bread, milk, sof drinks ec, bu asked o exclude pe food, alcohol, cigarees and meals ou. Takeaways eaen in he home are, however, included. To obain a weekly spending figure, each individual is assigned he mid-poin of heir repored band each year, adjused for inflaion in food prices. 9 Comparisons wih he more deailed spending informaion in he Family Expendiure Survey shows ha mean food spending in he BHPS is slighly higher han in he FES. 10 In par his may reflec he fac ha here are fewer observaions in he lowes bands in he BHPS (respondens may ignore aypical weeks when hey spend very lile). Alernaively, respondens may include oher grocery iems ha hey regularly buy a he 9 For wave 1, he coninuous answers are firs banded, and hen he midpoins are assigned. 10 To calculae he FES figures, he coninuous weekly spending figures are convered ino bands and hen mid-poins as in he BHPS. 10

12 supermarke such as washing powder, oile roll ec. When hese iems are included in he FES spending figures, he wo ses of numbers are very similar. Income and spending before and afer reiremen Table 3 summarizes household income and food spending for he wo groups of volunary and involunary reirees, averaged across all periods before reiremen and afer. Figures 4 and 5 presen he same informaion slighly differenly, showing he pahs of he variables in each of he hree years before, and he hree years afer, reiremen. In he figures, year 0 represens he firs year in which he individual is reired. Table 3: Mean income and spending Before reiremen Afer reiremen Real weekly household income Volunary reirees Involunary reirees Real weekly household food spending Volunary reirees Involunary reirees As would be expeced from heir higher level of qualificaions and occupaional groups, volunary reirees have higher average incomes prior o reiremen. Afer reiremen, however, average incomes of he wo groups appear o be very similar. Figure 4 shows ha boh groups experience a fall in income coinciding wih reiremen he fall is absoluely and relaively greaer for volunary reirees. The summary saisics provide evidence ha food spending a reiremen also behaves differenly for he wo groups. In spie of a bigger fall in income, volunary reirees experience a smaller fall in food spending. Their average food spending is around 3 a week lower afer reiremen han before; among involunary reirees average food spending afer reiremen is around 7 lower han i was pre-reiremen. This paern is refleced in Figure 5 for volunary reirees, he pah of spending is broadly mainained hrough reiremen, while for involunary reirees, here is evidence of a fall in spending around reiremen. These preliminary findings are consisen wih he hypohesis ha involunary reirees are more likely o experience a negaive wealh shock a reiremen ha causes hem o reduce spending. Bu, hey are no conclusive firsly because hey fail o conrol for oher facors (age, for example is relaed o well-being and varies sysemaically across he groups) and secondly, because of composiional changes (i.e. he sample 11

13 one year afer reiremen is no necessarily he same as he sample wo years afer reiremen and so on). The nex secion presens he resuls of regression analysis ha ries o conrol for boh hese facors. Figure 4: Average weekly real income ( ), by reiremen ype Volunary Involunary Real income Years before/afer reiremen mean income median income Graphs by invol Figure 5: Average weekly real food spending ( ), by reiremen ype Volunary Involunary Real weekly spending on food Years before/afer reiremen mean food spending median food spending Graphs by invol 12

14 3. Esimaion The esimaion approach is derived from a marginal-uiliy-of-wealh-consan consumpion demand funcion, or Frisch funcion (see Browning, Deaon and Irish (1985) and Blundell and Macurdy (1999)) Consumers are assumed o choose consumpion and leisure according o he value funcion: { U( C, L, X ) + E[ V ( A, 1) ]} V ( A, ) = max δ subjec o he following budge consrain: A + 1 = 1 ( + r)( A + B + W H C ) where d is he consumer s discoun rae, A is oal wealh, C is consumpion, L is leisure, X is a vecor of demographics, r is he (consan) ineres rae, B is unearned income, W is he wage rae and H is number of hours worked. This yields he following firs-order-condiion for he marginal uiliy of consumpion and he marginal uiliy of wealh,? (= V / A ): U λ C ( C, L X ) = λ [ λ (1 )] = δe r implying a consumpion demand funcion of he form, C = C λ, W, X ). ( This allows consumpion demand o be expressed as a funcion of an individual s curren characerisics (including wages) and a single saisic he marginal uiliy of wealh capuring all oher (expeced) fuure informaion ha deermines he level of consumpion oday. This will include he effec of reiremen where i is fully anicipaed. Wih uncerainy, shocks will be refleced in changes in he marginal uiliy of wealh from one period o he nex. I is possible o express he sochasic process for he marginal uiliy of wealh as follows: ln λ = b * + ln λ * * 1 + ε = bj + ln λ0 + j= 1 j= 0 ε * j (where b * depends on he discoun facor, he ineres rae and he momens of he forecas error e * ). Wih his specificaion, he marginal uiliy of wealh can be capured by an individual fixed effec,? 0, plus a funcion of age plus a random error erm, reflecing expecaional error in he curren period. 13

15 This allows consumpion demand o be modelled as a funcion of an individual s characerisics (X i ), age (A i ), an individual fixed effec (ω i ) and an expecaional error erm (u i ): 2 i = β' X i + γ1ai + δ g g= 1 ln C G R + ω + u i i Noe ha wages are no included direcly, bu are assumed o be deermined by he individual s characerisics and age. The expression for consumpion given here also includes a variable, R i for wheher he individual is reired or no, and an idenifier, G i, denoing which of he wo groups of reirees hey belong o (G i =1 if reiremen is volunary, =2 if reiremen is involunary). This ineracion erm is included in he esimaion o capure he exen o which spending (differenially) changes a reiremen for volunary and involunary reirees. If reiremen is fully anicipaed hen, under he model specified above, here should be no change in spending since he effec of reiremen would already have been capured in he (consan) marginal uiliy of wealh. Bu, if involunary reiremen resuls in a negaive shock o wealh hrough loss of earnings or pension accrual, reiremen will coincide wih an expecaional error ha causes consumpion o change. The ineracion erm is no inended direcly o esimae he effec on consumpion of reiremen per se, bu he exen o which reiremen and involunary reiremen in paricular is accompanied by an expecaional error ha resuls in a fall in spending. If he iniial hypohesis is correc, here should be a significan fall in spending only where reiremen is involunary. The assignmen of individuals ino groups of volunary and involunary reirees is somewha akin o an insrumenal variables approach. Ideally, wha I would like o include in he regression is wheher he individual experiences a negaive wealh shock on reiremen, bu his is unobserved. Insead, I include a erm if he reiremen is involunary, on he basis ha his is likely o be correlaed wih any unobserved wealh shock. As he analysis in he previous secion showed, involunary reiremen is more likely o occur as a resul of ill-healh or redundancy, boh of which are likely o mean loss of earnings and/or pension accrual. In order o inerpre a significan coefficien on involunary reiremen as an indicaor of a negaive wealh shock, here can be no direc link beween an individuals selfrepored employmen sae and heir level of spending. Clearly, his may no be rue in he case of ill-healh which is linked o involunary reiremen and may also have a direc effec on spending. The regression herefore includes a number of variables which aemp o conrol for healh saus. I is assumed ha oher facors ha may i i 14

16 resul in involunary reiremens do no have a direc effec on spending oher han hrough heir effec on being reired. Regression resuls Table 4 repors he resuls from he fixed effecs esimaion. In all cases, reiremen is included as a sae variable (ie R = 1 if he individual is reired). Because he BHPS asks abou usual spending on food, i is likely ha any repored change in food will be gradual and will be more likely o be picked up by he sae variable han by a ransiion variable. 11 The resuls in column (1) show ha, for he sample as a whole, here is a small, insignifican fall in spending afer reiremen. Column (2) shows he effec of adding a dummy for involunary reiremen. The regression resuls confirm he preliminary findings from he previous secion. The coefficien on reiremen, capuring he change in spending associaed wih volunary reiremen, is insignifican, bu for involunary reiremens he coefficien is negaive and significan: Involunary reiremen is associaed wih a fall in food spending of around 11% and his is significanly differen o wha happens o spending when reiremen is volunary. This is consisen wih he hypohesis ha involunary reiremen is associaed wih a negaive wealh shock ha causes a fall in spending. I is ineresing ha he fall in spending for involunary reirees occurs in spie of a significanly smaller drop in income (shown by he resuls in column (4)). Table 4: Main regression resuls Dependen variable (1) (2) (3) (4) Log food Log food spending spending Log food spending Log real income Reired ** Reired, Involunary ** ** ** Demographic conrols Yes Yes Yes Yes Healh conrols Yes Yes No Yes N Noes o able: Demographic conrols = household size, wheher he responden is divorced/widowed/separaed, wheher he spouse is working, age dummies Healh conrols = wheher he responden has healh problems, number of healh problems (if healh problems>0), wheher healh limis daily aciviies Sandard errors included in ialics, ** denoes saisically significan a he 5% level (wo-ailed ess) 11 There is no significan change in repored usual food spending when reiremen is included as a ransiion variable for any of he groups. 15

17 Conrolling for healh is paricularly imporan since ill-healh is a cause of involunary early reiremen and may have a separae direc effec on spending. The BHPS conains a large number of variables measuring individuals healh, bu only a limied number of healh variables in all en waves (see Disney, Emerson and Wakefield (2003) for a more deailed analysis of healh and labour marke exi using he BHPS daa). Here, wo variables are used as conrols for healh saus. One is he number of healh problems repored by he individual in each year (ou of a maximum of 13, including arms, legs and hands; sigh; hearing; skin condiions/ allergy; ches/ breahing; hear/ blood pressure; somach/ digesion; diabees; anxiey/ depression; alcohol & drugs; epilepsy; migraine and oher). The oher is wheher he individual repors ha heir healh limis daily aciviies. This variable is no presen in wave 9, bu a value can be impued on he basis of individuals responses in waves 8 and Column (3) repors regression resuls excluding hese healh conrols for comparison, bu here is lile change in he resuls. If anyhing, poor healh appears o be associaed wih an increase in food spending (possibly a subsiuion of home consumpion for meals ou) and he magniude of he coefficien on involunary reiremen is slighly larger in absolue erms when healh conrols are included. Robusness checks As discussed above, here is an ineviable degree of arbirariness in assigning individuals ino groups of volunary and involunary reirees and his raises he possibiliy ha he resuls may be parly driven by he chosen crieria. This is explored furher by re-defining reiremen as wo consecuive periods ou of work afer age 50 (following a leas one period observed in work). As before, individuals are assumed o reire volunarily if hey repor hemselves as reired and o be involunarily reired if hey repor anoher non-working sae, such as LT sick/ disabled or unemployed. The dae of reiremen is again aken o be he firs period ou of work. This is a less resricive definiion of reiremen here is no requiremen ha individuals do no re-ener work a a laer dae and here is no requiremen (for involunary reirees) ha hey self-repor hemselves as reired. Correspondingly, he sample size is slighly higher (325 reiremens). The fixed effecs regression resuls incorporaing his broader definiion of reiremen are repored in column (1) of Table 5. The basic resul is he same; here is no significan change in spending if reiremen is volunary, bu involunary reirees do experience a significan drop in spending. Using his broader definiion, however, he 12 For individuals who repor he same values in wave 8 and 10 his is fairly sraighforward. Where here is a change beween waves 8 and 10, he individual is assigned he value in wave 10 (where available), and oherwise he value in wave 8. I makes no difference o he resuls if, insead, he individual is assigned he value in wave 8 where available and wave 10 oherwise. 16

18 observed fall in spending is smaller less han 7%. This is no surprising since his broader definiion of reiremen poenially allows people who are defined as reired o re-ener work and, correspondingly, experience a smaller loss of earnings/ pension accrual. To explore his furher, column (2) includes emporary spells ou of work of no more han one period. 13 They oo are associaed wih a significan fall in spending, bu his drop is smaller again han in he case of spells of involunary reiremen of wo or more periods ou of work. Moreover, as shown in column (3), he drop in spending ha occurs wih a emporary spell ou of work is more srongly linked o conemporaneous income. In general, hese resuls imply ha he more permanen he involunary spell ou of work (and he greaer he loss of earnings and pension accrual), he larger he fall in spending. Table 5: Robusness checks definiion of reiremen Dependen variable = (log) weekly real spending on food Reired (1) (2) (3) Reired, Involunary ** * Temporarily ou of work ** Log real income No No Yes Demographic & healh conrols Yes Yes Yes N Noes o able: Demographic & healh conrols as in Table 4 Reired = wo consecuive periods no in work Sandard errors included in ialics ** denoes saisically significan a he 5% level, * a he 10% level (wo-ailed ess) An alernaive explanaion for why spending a reiremen behaves differenly for volunary and involunary reirees migh be ha i reflecs, no a negaive wealh shock associaed wih involunary reiremen, bu some of he differences in heir characerisics. To explore his, furher regressions are run incorporaing addiional ineracion erms o pick up differences in spending a reiremen by, respecively, age of reiremen, occupaional pension saus and educaional qualificaion. The resuls are repored in Table 6. Noe ha he original, narrower definiion of reiremen is used. 13 i.e. someone is no working in one period, bu is in work in he periods immediaely before and afer 17

19 Firs, age of reiremen. Involunary reirees reire earlier, on average, han volunary reirees. Column (2) in panel (a) repors he resuls when separae ineracion erms are included for volunary reiremens ha occur a age 65 (he sae pension age) and afer age 65. When hese addiional erms are included, and involunary reiremen is compared o volunary reiremens occurring a a similar age (ie before age 65), he coefficien on involunary reiremen becomes even larger (in absolue erms). Thus, he drop in spending when reiremen is involunary can no be aribuable o he fac ha people reire before he sae pension age. The resuls in column (1) in panels (b) and (c) lend suppor o he idea ha he drop in spending among involunary reirees may be linked o heir lower level of occupaional pensions and/or educaional qualificaions (he wo are correlaed). If no accoun is aken of wheher reiremen is involunary or volunary, changes in spending a reiremen are srongly correlaed wih pension saus and educaional qualificaions. Spending falls significanly a reiremen if someone does no have an employer pension, bu no if hey do (column 1, panel b). Similarly, spending falls significanly a reiremen for someone wih no educaional qualificaions, bu no for someone wih qualificaions (column 1, panel c). Bu, if pension saus is furher ineraced wih volunary/ involunary reiremen saus, he resuls in column (2) show ha wheher or no reiremen is volunary or involunary also maers. Wihin he group of men wih no employer pension, i is only hose who reire involunarily who experience a significan fall in spending (panel b), while hose who reire involunarily and do have an employer pension experience a (smaller) fall in spending ha is significan a he 10% level. I is a similar sory wih educaional qualificaions. Wihin he group of men wih no qualificaions, i is only hose who reire involunarily who experience a significan fall in spending (panel b). In his case, however, here is no significan fall in spending among hose who reire involunarily and do have higher qualificaions. 18

20 Table 6: Robusness checks characerisics of reirees Dependen variable = (log) weekly real spending on food Panel a: Age of reiremen (1) (2) Reired Reired, Involunary ** ** Reired a 65, Volunary Reired > 65, Volunary Demographic & healh conrols Yes Panel b: Employer pension (1) (2) Reired Reired, No employer pension ** Reired, Volunary, No employer pension Reired, Involunary, Employer pension * Reired, Involunary, No employer pension ** Demographic & healh conrols Yes Panel c: Qualificaions (1) (2) Reired Reired, No qualificaions ** Reired, Volunary, No qualificaions Reired, Involunary, Qualificaions Reired, Involunary, No qualificaions ** Demographic & healh conrols Yes Yes Noes o able: Demographic & healh conrols as in Table 4 Sandard errors included in ialics ** denoes saisically significan a he 5% level, * a he 10% level (wo-ailed ess) 19

21 These resuls confirm ha here is a significan difference in spending a reiremen beween volunary and involunary reirees. In cases where reiremen is volunary, here is lile evidence o sugges ha spending on food falls, even for hose wih no employer pension and no educaional qualificaions. Bu, he fall in spending associaed wih involunary reiremen is bigger for hose wih no employer pension (compared o hose wih an employer pension) and only significan for hose wih no educaional qualificaions (compared o hose who do have educaional qualificaions). Boh hese characerisics are likely o reflec low levels of lifeime wealh, which may give individuals less of a cushion agains negaive wealh shocks. 4. Conclusions The earlier UK sudy of consumpion a reiremen by Banks e al (1998) concluded ha he evidence srongly suggess ha here are unanicipaed shocks occurring around he ime of reiremen. Banks e al (1998) and Bernheim e al (2001) found a smaller drop in spending when reiremen was anicipaed, bu he resuls depend on he validiy of he insrumens for reiremen lagged reiremen and age respecively. This paper akes a differen approach o looking a he effec of unanicipaed early reiremen and looks direcly a he evidence on he naure of reiremen. The main finding is ha food spending only falls significanly when reiremen is involunary, occurring as a resul of ill-healh or redundancy for example, and no when reiremen is volunary. This finding is robus o alernaive definiions of reiremen and canno be explained in erms of differences in pension saus and levels of educaion beween volunary and involunary reirees. Bu, among he group of involunary reirees, hose wih no occupaional pension experience a larger fall in spending and only hose wih no educaional qualificaions experience a significan fall in spending. This main finding is consisen wih he hypohesis ha unanicipaed early reiremen is associaed wih a negaive wealh shock ha causes a drop in spending, in paricular where lower levels of lifeime wealh mean ha people are less able o cushion he effecs of an adverse shock. The BHPS evidence suggess ha up o 40% of men may reire involunarily defined by he reason given for early reiremen or he roue ino reiremen. Given he magniude of he fall in food spending among involunary reirees (beween 7% and 11% depending on he definiion used), his would be enough o explain he reiremen-consumpion puzzle (3% fall in oal non-durable spending) observed in he earlier UK sudy. The bigges limiaion wih his sudy is ha i is resriced o food spending. If spending on a basic iem such as food falls, hen oal spending is almos cerain o fall, bu he same canno be said if food spending does no fall. The BHPS collecs 20

22 informaion on wo furher iems of personal spending meals ou 14 and leisure bu only in more recen waves and he sample sizes are no large enough o gain significan resuls. Neverheless, he resuls of preliminary analysis of leisure spending are consisen wih he main finding spending on leisure falls by 3 a week when reiremen is volunary and by 15 a week when reiremen is involunary. As furher waves of he BHPS become available, his is somehing o reurn o in he fuure. Appendix The able below provides furher deail on how individuals are caegorized as volunary or involunary reired. The sequence of employmen saes (work or nonwork) in (up o) he five periods prior o he individual reporing hemselves as reired is analyzed. If he individual is working in (a leas) wo consecuive periods immediaely prior o reiremen, hey are classed as reiring volunarily. If hey experience a period of no-working immediaely prior o reiremen, bu have previously been observed working, hey are classed as reiring involunarily. Pre-reiremen sequence W = working, NW = no working Reiremen ype Number of observaions W_W Volunary 49 W_NW Involunary 8 W_W_W Volunary 21 W_W_NW Involunary 6 W_NW_NW Involunary 5 W_W_W_W Volunary 20 W_W_W_NW Involunary 11 W_W_NW_NW Involunary 3 W_NW_NW_NW Involunary 2 W_W_W_W_W Volunary 133 W_W_W_W_NW Involunary 8 W_W_W_NW_NW Involunary 5 W_W_NW_NW_NW Involunary 4 W_NW_NW_W_W Volunary 2 W_NW_NW_NW_NW Involunary 5 NW_W_W_W_W Volunary 1 TOTAL Meals ou include meals eaen a work and so is a heavily work-relaed iem of spending. 21

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