Are pensions a substitute for children?

Vincenzo Galasso, Roberta Gatti, Paola Profeta, Mon, 05/12/2008



In the last century most countries experienced both an increase in pension spending and a decline in fertility rates. In traditional societies, old age support was guaranteed by intergenerational transfers within the family from young to old, but the weakening of family ties in modern societies has justified the introduction of social security systems, thus reducing the incentive to have children. The authors of CEPR DP6825 argue that pension generosity and development of capital markets are crucial to understand fertility decisions, as the role of children as a form of retirement saving for their parents is particularly strong in economies with limited or non-existent access to financial markets.

Using a simple OLG model and a cross-country regression analysis, the authors show that in economies with limited capital markets where the saving instrument is more costly, individuals are almost forced to invest in children, i.e. to become parents under the expectation that children will transfer resources back to their parents when they reach old age. An exogenous increase in pension spending is associated with a large decrease in fertility as it amounts to relaxing the financial constraints of the current generation.

The PAYG scheme may insure against risk of being infertile or not finding an appropriate partner, by pooling individuals together, who may thus also receive a pension from other people’s children. This argument is particularly relevant when capital markets are not efficient and children represent the only mean of transferring resources intertemporally. Previous studies have argued that about 50% of the fall in fertility over time can be explained by the growth in the pension system and that in societies with difficult access to financial instruments, improvements in capital market efficiency or returns may significantly contribute to decrease in fertility. The authors believe their study provides important policy implications, some of which are relevant to developing countries currently dealing with defining their modern social security systems as well as middle- and high-income countries tackling issues of pension system sustainability.

Summarised by CEPR staff

DP6825 Investing for the Old Age: Pensions, Children and Savings

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Topics:  Welfare state and social Europe

Tags:  financial markets, fertility, intergenerational transfers, PAYG pension systems


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