Transfers and Labor Market Behavior of the Elderly in Developing Countries : Theory and Evidence from Vietnam

When private transfers respond endogenously to the retirement decision of the elderly, they directly lower the opportunity cost of not working and magnify the income effect of public transfers. In this paper we show that the interaction of private transfers with the labor market decision of the elderly indeed magnifies the crowding-out effects of public transfers on the elderly’s labor supply (or retirement choice) in developing countries. We also find that this economic mechanism has important implications for evaluating the crowding-out effect of public transfers in developing countries, where there are large flows of private transfers within and between households. More specifically, we show that a misspecified econometric model that does not control for the endogeneity of private transfers leads to a biased estimate of the crowding-out effect of public pensions on the elderly’s retirement decision. Using data from a household survey in Vietnam we find that the effect of public pensions on the probability of retirement is 2.5 times larger when explicitly accounting for the interaction between private transfers and the retirement decision of elderly individuals