FRBSF Economic Letter: Life-Cycle Shocks and Income

Households experiencing income shocks rely upon their own resources to make up for the income loss more than they rely upon social insurance:

Life-Cycle Shocks and Income, by Kenneth A. Couch, Mary C. Daly, and Colin Gardiner, FRBSF Economic Letter: Unexpected events such as job displacement, disability, and divorce can have negative effects on individual and family income. For many families, social insurance provided by the government plays an important role in buffering the impact of these shocks. However, on average, Americans depend more on private resources rather than the public sector to insure against these losses.

Life-cycle shocks such as job loss, disability, and divorce can have large effects on individual and household economic well-being. Understanding these impacts is important for designing and maintaining an adequate social safety net. In this Economic Letter, we examine how these shocks affect family income. We trace the path of total family income before and after job displacement, the onset of a disability, or divorce. We then examine the components of total family income, including labor earnings, transfer payments, and other income, and look at how each responds to these shocks. We find several important patterns. The U.S. social safety net helps mitigate the impact of these shocks, but on average offsets only a portion of the losses. Private actions, including drawing on savings or increased employment of other family members, also play an important role in offsetting income losses following shocks. The combination of public and private measures significantly offsets losses in total family income, even when an individual’s earnings fall severely as a result of a shock. ...

Conclusion ...Work-limiting disabilities, job losses, and divorces generally have damaging economic effects. For the most part, individuals and families respond to these shocks privately. In the case of families whose principal income earner becomes disabled, other family members increase their income from labor to offset lost earnings. On average, job displacement permanently reduces an individual’s earnings. However, other family members respond by increasing their work activity. Similarly, prime-aged workers on average make up for the large earnings loss that typically follows divorce by adding income from new family partners. Social safety net insurance is important in mitigating the circumstances of those who experience the most severe unexpected life-cycle shocks, such as an incapacitating disability. However, on average, most post-shock family income comes from the earnings of family members. If a life-cycle shock causes the principal earner to lose income, other family members take up all or most of the slack by increasing their own earnings. The data suggest that Americans depend mostly on their own families for the resources necessary to weather unexpected economic events. ...

The Letter doesn't say much about whether this is the optimal level of social insurance -- I think we need more -- but it does knock down the idea that Americans rely mainly upon the government to insure themselves against unexpected declines in family income and hence lack the motivation to take action on their own to offset the income loss.