Wage and Earnings Profiles at Older Ages

The inverted U shape of the lifetime real wage profile is frequently taken to be a stylized fact. This implies a smooth decline in wages as workers approach retirement. Instead, this paper shows that the hourly wage of the typical older worker increases slightly with age for as long as he is employed full time. It declines discretely only when he enters partial retirement, a transitional period characterized by the prevalence of part-time work, and remains mostly at thereafter. That is, the wage path at older ages is best represented by a step function. The smoothly-declining profile often found in the literature is the result of aggregation over individuals who enter partial retirement at different ages. This conclusion is robust to controlling for self-selection into partial and full retirement. More importantly, the transition out of full time work is a choice for most workers, and the subsequent wage change is endogenously determined. While standard labor supply models would rationalize the reduction in hours worked upon partial retirement as a response to an exogenously declining wage trajectory, the evidence presented in the paper indicates instead that workers choose to trade more leisure for a lower hourly wage in a context in which a better paid, full-time job is available. In other words, wages and hours are jointly determined at older ages. These findings have important implications for the analysis of saving and labor supply decisions over the life cycle.