Estimation of a Life-Cycle Model with Human Capital, Labor Supply and Retirement - Research paper

Sep 15, 2026

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We develop and estimate a life-cycle model where individuals jointly decide consumption, human capital investment, and labor supply. Retirement is endogenous, emerging from the labor-supply choice rather than being imposed separately. The framework features an endogenous wage process driven by human capital investment and an endogenous retirement decision, addressing limitations in prior retirement and human-capital approaches. Estimated via Indirect Inference using SIPP data, the model matches wage and hours profiles. Endogenous human capital fits best, learning-by-doing fits overall patterns, and exogenous human capital fails; both endogenous labor supply and human capital investment are essential.

LanguageEnglish

CategoryResearch & Report

FormatPDF

Pages55

Reading Time2 h 19 min

AccessFree to download

Abstract

Introduction

Retirement as an endogenous outcome

Model development and estimation

Human capital depreciation and end-of-life labor decisions

Estimation of a Life-Cycle Model with Human Capital, Labor Supply and Retirement 􀀃 Xiaodong Fan Ananth Seshadri University of New South Wales University of Wisconsin-Madison Christopher Taber University of Wisconsin-Madison April 15, 2015 Abstract We develop and estimate a life-cycle model in which individuals make decisions about consumption, human capital investment, and labor supply. Retirement arises endogenously as part of the labor supply decision. The model allows for both an endogenous wage process through human capital investment (which is typically assumed exogenous in the retirement literature) and an endogenous retirement decision (which is typically assumed exogenous in the human capital literature) . We estimate the model using Indirect Inference to match the life-cycle proﬁles of wages and hours from the SIPP data. The model replicates the main features of the data—in particular the large increase in wages and small increase in labor supply at the beginning of the life-cycle as well as the small decrease in wages but large decrease in labor supply at the end of the life cycle. We also estimate versions of the model in which human capital is completely exogenous and in which human capital is exogenous conditional on work (learning-by-doing) . The endogenous human capital model ﬁts the data the best; the learning-by-doing model is able to ﬁt the overall life-cycle pattern; the exogenous model does not. We ﬁnd that endogenous labor supply is essential for understanding life-cycle human capital investment and life-cycle human capital investment is essential for understanding life-cycle labor supply. KEYWORDS: human capital, Ben-Porath, labor supply, retirement JEL Classiﬁcation: J22, J24, J26 􀀃 We would like to thank seminar participants at the SED, Tokyo, Yale, SOLE, CEPAR, Reading, Royal Holloway, Catholic University of Milan, Toulouse, and Johns Hopkins for helpful comments and suggestions. All remaining errors are our own. 1 Introduction The Ben-Porath (1967) model of life-cycle human capital production and the life-cycle labor supply model are two of the most important models in labor economics. The former is the dominant framework used to rationalize wage growth over the life-cycle; the latter has been used to study hours worked over the life-cycle, including retirement. Quite surprisingly, aside from the seminal work in Heckman (1976, 1975), there has been little effort integrating these two important paradigms. This paper attempts to ﬁll this void by estimating a life-cycle model in which workers choose human capital and labor supply jointly. Perhaps the most important aspect of our model is that we do not treat retirement as a separate decision. It occurs endogenously as part of the optimal life-cycle labor supply decision. The retirement literature typically takes the wage process as given and estimates the incidence of retirement. Cross-section raw wages for people who work fall substantially before retirement. They decline by over 25% between ages 55 and 65 . In much of the retirement literature, this trend is critical to understanding retirement behavior. By contrast, life-cycle human capital models take the retirement date as given, but model the formation of the wage process. While most work to date on the life-cycle human capital model aims to explain wage growth early in the life-cycle, there has been little work studying the interaction between human capital and labor supply at the end of the working life. We estimate a model wherein the wage, labor supply and retirement choices are rationalized in one uniﬁed setting. After endogenizing both labor supply and human capital, this model is rich enough to explain the life-cycle patterns of both wages and labor supply, with a focus on wage patterns and retirement at the end of working life. Speciﬁcally, we develop and estimate a Ben-Porath type human capital model in which workers make consumption, human capital investment, and

FAQs

What decisions does the life-cycle model include?

Individuals choose consumption, human capital investment, and labor supply jointly over the life cycle. Retirement is not modeled as a separate step but arises endogenously from the labor-supply decision.

How is the model estimated and what data are used?

The model is estimated using Indirect Inference. It matches life-cycle profiles of wages and hours using SIPP data for male high school graduates.

Which assumptions about human capital best fit the data and why?

The endogenous human capital version fits the data best, while the learning-by-doing version fits the overall life-cycle pattern. The fully exogenous human capital model does not fit, largely because the interaction of depreciation costs with leisure and re-entry matters for wages and labor supply near retirement.

Sep 15, 2026

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