Family Size, Looming Demographic Changes and the Efficiency of Social Security Reform

This paper analyses the eeffects of ageing and child support in a model with endogenous fertility and Pay-As-You-Go (PAYG) pensions. First, we show that the endogeneity of fertility makes society vulnerable to both pessimistic beliefs and changes in life expectancy. In particular, we show that the private fertility choice may not coincide with the social optimum, due to the existence of two external effects of a child on society as a whole. The market outcome without government intervention is efficient, however, as both externalities exactly cancel out in that case. If the government wants to redistribute towards the old, it cannot replicate the command optimum by merely applying lump-sum transfers, but rather needs a child allowance scheme to effectively alter the number of offspring chosen by households. Finally, we analyse whether a Pareto-improving social security reform is possible. It is shown that a mere reduction of the PAYG-scheme cannot be Pareto-improving, but a combined policy of decreasing the PAYG-tax and introducing child allowances can be.