The welfare effects of nonlinear health dynamics

Abstract: We generate a continuous measure of health to estimate a non-parametric model of health dynamics, showing that adverse health shocks are highly persistent when suffered by people in poor health. Canonical models cannot account for this pattern. We incorporate this health dynamic into a life-cycle model of consumption, savings, and labor force participation. After estimating the model parameters, we simulate the effects of health shocks on economic outcomes. We find that bad health shocks have long-term adverse economic effects that are more extreme for those in poor health. Furthermore, bad health shocks also increase the disparity of asset accumulation among this group of people. A canonical model of health dynamics would not reveal these effects.