Labor Substitutability and The Impact of Raising the Retirement Age [JOB MARKET PAPER]

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The degree of substitutability among different types of workers can affect the incidence of public policies by creating labor demand spillovers within firms. We study the substitutability between age cohorts in the context of an unexpected public pension reform increasing the full retirement age in Italy starting in 2012.  An increase of the full retirement age creates incentives for older workers to delay retirement and temporarily increases their retention at the employer firm. We investigate how retaining an additional senior worker affects employer labor demand for other workers. Using a large and rich matched employer-employee administrative data set for Italy, we exploit the substantial idiosyncratic firm-level variation in the impact of the unanticipated pension reform even after conditioning on the broad demographics of firms' work forces. We find that workers on the cusp of retirement and younger co-workers are substitutes. When a workers is retained firms fire on average 0.16 workers more and decrease hiring by 0.29 units. Older workers in the same occupation group are the closest substitute to the retained older workers who delay retirement. Extending the retirement age also decreases labor earnings and increases the take-up of social security programs for incumbent workers. We evaluate the implications of the observed patterns of labor-labor substitutability for the incidence of the policy by estimating the fiscal cost of the public pension reform in the short-run. We use a government accounting model that allows for both substitution across government programs and for spillovers from delayed retirement onto other incumbent workers. Our findings indicate that the labor demand spillovers explain almost all the short-run fiscal cost of the policy in the first four years after implementation.

Last updated on 01/15/2019