FINANCIAL WEALTH AND RETIREMENT
or by borrowing, so that the mandatory savings simply crowd out other savings (see chapter 4). Thus, pension wealth does not increase, and labour supply is not affected at any age. Yet, if the individual does not possess enough private savings and he cannot borrow on the capital market against his future retirement benefits, then total savings will rise and illiquid pension wealth increases. If pension wealth can only be obtained by retirement from the labour market, wealth can have a much larger impact on retirement decisions due to credit constraints. Many economists acknowledge that capital markets are imperfect, and that a non-negligible share of individuals is liquidity constrained. Hence, mandatory wealth accumulation may lead to more savings and earlier retirement. A second reason for a larger wealth effect than textbook models predict is labelling. That is, the individual’s expenditure may depend on the source of income. In particular, it could be the case that individuals tend to spend their early retirement wealth on early retirement. This fits into the theory of mental accounting, see for example Thaler (1990). As logical as it may sound, such behaviour is often irrational from the life-cycle point of view: a wealth increase should be spent where it maximises the individual’s utility, irrespective of the source of income. A rational agent following the life-cycle model would typically smooth a wealth increase over his remaining life-cycle and allocate it to different goods, services and/or leisure. Although there is virtually no empirical evidence on a labelling effect of early retirement wealth, many believe it is relevant to some extent. Some empirical evidence does exist for other applications, such as child benefits (Kooreman, 2000). The size of the impact of wealth on retirement is an empirical issue. Imagine that an individual has a preference to retire early. He carefully plans an optimal working and consumption path over the life cycle (chapter 5). Say the individual incorporates mandatory early retirement wealth accumulation in the plan, but a policy reform reduces this wealth with one year salary. Will the individual postpone early retirement with one full year? Or will the individual accumulate more wealth to retire early and/or retire with a lower pension? A number of studies explore the impact of mandatory early retirement and pension wealth on the decision to retire. An overview of empirical estimates can be found in Lumsdaine and Mitchell (1999). Overall, these empirical studies suggest that the wealth effect on retirement is small. Note that empirical estimates are typically estimated within reduced-form models. Hence, no distinction is made between the pure wealth effect and liquidity constraints or mental accounting. The finding of a small wealth effect suggests that these complicating factors are of limited relevance. Krueger and Pischke (1992) find that a reform in the US state pension did not affect labour supply, indicating a zero wealth effect. Euwals, van Vuuren and Wolthoff (2006) find a statistically significant but limited effect of early retirement and pension wealth for the Netherlands. They find that a wealth increase of about one year-salary on average implies nearly two months earlier retirement. Banks, Emmerson and Tetlow (2007) find virtually the same effect for the UK. They find that a reduction of pension wealth of about one year-salary leads to a postponement of early retirement of about two months. Few studies look at the impact of general wealth. Joulfaian and Wilhelm (1994) find that inheritances have a relatively modest 57