Dynamic Incentives: Temporary Vs. Permanent Disability

This article extends Diamond and Mirrlees’ (1978) disability model in a different and more detailed framework that contemplates both temporary and permanent disability. By introducing different degrees of disability into this seminal framework, the paper contributes to the recent debate among empirical scholars on the growth of disability insurance programmes in several OECD countries (e.g., the US, Norway, Sweden). This approach allows us to analyse and consequently compare able, temporarily disabled, and permanently disabled workers. Furthermore, in a numerical simulation, the analysis demonstrates that the system of dynamic incentives should adapt the disability benefits to the different disability statuses