The Magazine

Gunnar Myrdal Was Right

Social Security's fertility problem.

May 7, 2007, Vol. 12, No. 32 • By JAMES C. CAPRETTA
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Barring a political earthquake, President Bush will leave office without achieving his goal of transforming Social Security. That's too bad. A successful Social Security effort would be a significant down payment on much needed entitlement reform. But sooner or later, Social Security will find its way back onto the public agenda. The program's financial problems are simply too big to set aside indefinitely.

In a nutshell, Social Security's long-term prospects are bleak because of rapid and unprecedented population aging. Part of the demographic story is, of course, good news about longer lives. When Social Security started, the average man could expect to live about 12 years after reaching retirement at age 65. Today, he can expect to live 16 years.

But by far the most important factor in aging over the long run is falling fertility. Societies that do not produce children will, quite naturally, grow older. And there is simply no bigger problem than a low birth rate for a conventional "pay-as-you-go" pension system like Social Security. Without a steady stream of "payers," the system cannot "go."

What is not widely understood--despite the work of analysts like Allan Carlson, Phillip Longman, and John Mueller, among others--is that Social Security itself contributes significantly to the problem of low fertility. Odd as it may sound to the modern ear, a primary motivation for having children in earlier times was economic security in old age. As parents became frail and less productive, it was expected that one or more of their adult children would take care of them, oftentimes by bringing them into their homes. Married couples thus "invested" in numerous children, in part, to ensure there would be family members to care for them in their twilight years. With state-run Social Security, the government has largely assumed this family responsibility. Married couples have a greatly diminished economic incentive to have children, because now they are counting on--and paying for--government-based old age support.

This insight is neither new nor conceived of by conservative opponents of the welfare state. As noted frequently by Carlson, Gunnar Myrdal, the eminent Swedish socialist economist, observed in the 1940s that state-run, pay-as-you-go pension systems are built on a fundamental "contradiction": They reduce the economic incentive within a family to have children, even as they remain ever dependent on a new generation of productive workers.

The evidence for Social Security's role in fertility decline is compelling and has been confirmed by numerous researchers. A 2005 study by economists Michele Boldrin, Mariacristina De Nardi, and Larry Jones found that a government-run pension system equal to 10 percent of a country's economy correlates with a reduction in the Total Fertility Rate (TFR)--which measures the average number of births per woman during her lifetime--of between 0.7 and 1.6 children, after controlling for other variables (no one suggests government pensions are the only reason fertility has dropped).This is extraordinary given that most industrialized countries now have TFRs well below 2.0. Importantly, this research indicates that program size matters. The bigger the Social Security scheme, the steeper the fertility decline.

Japan, now the world's oldest society, presents a striking case study. Government spending on Japan's state-run pension system increased dramatically in recent decades, from about 1.3 percent of national income in 1965 to more than 12 percent today. During this same period, Japan's TFR fell from about 2.0 to 1.3. The economic consequences of this plunging birth rate will be severe in the years ahead, as the workforce contracts significantly. Japan's working age population--those ages 20 to 64--is expected to decline from 79 million in 2000 to just under 50 million in 2050, a 37 percent drop. With a smaller workforce expected, Japan has been forced to reform its Social Security program three times since 1994 and has scheduled a 0.354 percentage point payroll tax rate hike every year between 2004 and 2017--increasing the tax from 13.6 percent of wages to 18.3 percent. The evidence suggests that this tax increase will only serve to further suppress the one variable that could eventually bring Japan back from the brink--more children and, therefore, more future workers.

The pattern is similar, if not as dramatic, throughout the developed world, including in the United States. The Total Fertility Rate fell precipitously as Social Security expanded in size, from a high of 3.5 in 1955 to a low of 1.8 in 1975. It has since recovered slightly to 2.0. Today, France has a TFR of 1.9, the U.K. is at 1.6, and Germany, Italy, and Canada all have TFRs below 1.4.