Understanding the Aggregate Effects of Disability Insurance

Abstract

We study the aggregate consequences of the Social Security Disability Insurance (DI) program, focusing on the role of complementarity between heterogeneous human capital. First, we develop and estimate a wage process in which individuals’ human capital is composed of (pure) labor and experience, and their efficiencies are affected by disability. We find that older workers are more experience-abundant, and that disability causes a smaller loss in the efficiency of experience than it does in the efficiency of labor. Further, the estimated aggregate production technology shows that labor and experience are complementary inputs. Combining these empirical results with a structural general equilibrium model, we analyze the labor market implications of removing the DI program. Removal of the DI program induces an increase in the relative supply of experience, thus affecting the marginal products of inputs and wages of all workers in the economy. While the entry of less productive workers lowers the average productivity of the workforce, its negative effect is limited because of the complementarities between labor and experience.

Keywords: disability insurance, labor supply, wage risk, skill complementarity, human capital

JEL Classification: J31, J24, E24, I18, I38