Health and Earnings: a General Equilibrium Evaluation

Abstract

We study the economic impact of changes in health focusing on one specific transmission channel: earnings. We develop a general equilibrium model where earnings are affected by health status and shocks, and workers may influence the level of their health status through investment. After calibrating the model for the U.S., we perform two sets of exercises. First, we simulate the occurrence of a large and transitory health shock that has the characteristics of one of the worst health catastrophes in modern times, the 1918 influenza pandemic. We estimate that efficient labor drops on impact by more than 4%, inducing a fall of approximately 30 basis points in the return to assets and a moderate increase in the wage rate. The implied output loss amounts to roughly 3%. These effects—especially on prices and consumption—are persistent. Second, we do a comparative steady-state analysis in order to measure the effects of permanent changes in health resulting from policy changes. We show that omitting general equilibrium effects (e.g., prices effects) produces a bias in measuring the impact of health risks’ changes.