The Effect of Health on the Marginal Utility of Consumption for Retirees in Europe

This paper investigates the effect of health on marginal utility of consumption for the elderly population in Europe. The method used is based on the approach of Finkelstein et al. (2008) and includes Mundlak (1978) variables to account for correlated unobserved heterogeneity. The model is estimated using data from the Survey of Health, Ageing and Retirement in Europe (SHARE), and financial wellbeing is chosen as a proxy for utility. The baseline results show that when an individual who is healthy experiences an adverse health shock, the marginal utility declines with 15.9 percent. Correspondingly, the point estimate indicates that a one-standard deviation increase in an individuals’ limitations in activities of daily living (ADL) is associated with a 3 percent decline in marginal utility. Hence, negative health state dependence is observed. Unfortunately, the findings are very sensitive to the proxy for utility and the choice of health measure. Moreover, results indicate that there is a positive association between numeracy and health state dependence. No health state dependence was found for individuals with a higher than average level of numeracy. For individuals with a lower than average level of numeracy, an adverse health shock results in a decline in marginal utility of 17.7 percent, which is higher than in the baseline model.
Hence, numeracy positively influences health state dependence. Governments could provide funded financial education to raise the level of numeracy in order to lower the negative implications that an adverse health shock has on the marginal utility.