Health Shocks and Consumption Smoothing: Evidence from Indonesia

Episodes of uninsured illness can seriously compromise a household's well-being. This article provides further evidence on the consequences of illness episodes on earnings and consumption in Indonesia. We exploit a rich panel data set that allows us to combine fixed effects and instrumental variables to address biases associated with the endogeneity of illness. Using deteriorations in physical functioning to measure illness for a sample of prime-age individuals, we find that earnings are significantly reduced. However, the effects on consumption are relatively small and statistically insignificant. In addition, we explore informal mechanisms that households may be using to smooth out the consequences of these episodes. In particular, we study whether households deplete liquid assets or receive transfers from noncoresident kin. Transfers are responsive to illness, but there is no evidence of asset depletions. Overall, our findings suggest some ability to smooth the income effects of illness on average. Nonetheless, our analysis is subject to some important caveats that highlight the difficulties of identifying these effects and the need for more careful research on this relevant question.