Three essays on population economics

THREE ESSAYS ON POPULATION ECONOMICS SHI YUHUA (M.Soc.Sci., NUS) A THESIS SUBMITTED FOR THE DEGREE OFDOCTOR OF PHILOSOPHY DEPARTMENT OF ECONOMICS NATIONAL UNIVERSITY OF SINGAPORE (2006) ACKNOWLEDGEMENTS I am indebted to all who encouraged and supported me to complete my graduate study in the National University of Singapore. First, I would like to take this opportunity to express my sincere gratitude to Professor Tay Boon Nga, my advisor who has always been supportive, encouraging, understanding, considerate and friendly. We have been exchanging opinions on research— approaches; methodologies, and interpretations; we also talked about issues in life. He was always there to listen and give advices. His virtue of honesty and goodness has inspired me and made my academic study in Singapore a pretty nice memory. My special thanks also go to Professor Zeng Jinli, my supervisor who is most responsible for helping me complete my dissertation and academic program. He has spent much of his valued time to meet me and discuss my ideas, give me suggestions and guidance; teach me how to write academic papers, show me the techniques in doing simulations; bring good ideas to make me think through my problems and encourage me like a friend when I had difficult times while the research was not going on very well. Without his constant guidance, I could not have finished this dissertation. I am very grateful to Professor Zhang Jie, a member in my thesis committee. He has taught me to have deeper understanding on the insights and intuitions of the models, the skills to deal with multi-dimension models; gave suggestive ideas and showed me the ways to illustrate my ideas. I have also learnt from him that hard-working will always harvest. I would like to thank Professor Tilak Abeysinghe for asking me good questions and commenting on my papers. i Last, but not least, I thank my family: my parents, Shi Guangfu, and Lu Xiugui, for giving me life for the first place, for educating me and unconditional support. Thanks other family members for their encouragement and confidence in me. ii TABLE OF CONTENTS Acknowledgements i Table of contents iii Summary iv List of tables vi List of figures vii Essay Public policies on high fertility rates in developing countries: birth control, birth taxes or education subsidies? Essay Income growth, health expenditure, education investment: the 36 effects on population growth Essay Population aging, welfare, intergenerational transfers – the 63 pension needs of an elderly society: the case of China Bibliography 102 iii SUMMARY This dissertation contains three essays on population economics. The first essay focuses on the welfare comparisons of different population policy options. With special concern on China’s “one-child” population policy, we propose an alternative policy instrument for China that will perform better in increasing human capital investment, lowering fertility, and improving economic growth. In this paper we consider two types of population policies: one through birth control as in China and the other through birth taxes. We find that both achieve the same equilibrium solution if tax revenue finances lump-sum transfers. By reducing fertility and promoting growth, these policies may achieve higher welfare than conventional education subsidies financed by income taxes. A birth tax for education subsidies can achieve the first-best solution. The welfare gain of the first-best policy may be equivalent to a massive 10-50 percent rise in income, depending on the degree of human capital externalities. The second essay discusses the effects of health investment on the survival rate of the population, and its consequent effects on the fertility transition and economic growth. In this essay, we incorporate mortality variable into the endogenous growth model, where agents choose between consumption, fertility choice, human capital investment and health investment to prolong life span. The result suggests that health investment increases along with income growth; fertility rate increases first and declines steadily toward the steady state level as the survival rate of agents rises with increasing health investment. A subsidy on health expenditure triggers a faster decline in fertility rate and leads to an increase in children's education, and hence income growth. iv The third essay pays special concerns on the problems of population aging, and the resulted problems on old-age support in both developed countries and in some developing countries. The reform in pension system is another important issue. This essay briefly reviews the cause of aging due to changing demography, and the changing of population age distribution. It conducts a short survey on the economic consequences caused by aging, i.e., the interactions between aging, saving and intergenerational wealth transfers, and how these factors response to unfunded and funded pension systems. With special attention on China's aging problem, this essay also reviews the features of China's pension systems under the planned economy and the new market-oriented economy; and reports the projections on aging and the financial needs for pension in China. An accelerating aging makes it difficult for China to take care of the pension needs of the elderly, as China is a low- or middle-income country that is facing challenges in its structural reform in every aspect. v LIST OF TABLES Table 1.1 A comparison – summary of results with different government policies 34 Table 1.2 Numerical results 35 Table 2.1 Simulated results – case of sustainable growth 58 Table 2.2 Simulated results – case with health spending subsidy 59 Table 3.1 Comparison of pace of aging in selected countries 99 vi LIST OF FIGURES Figure 2.1 Fertility change in response to change in survival rate 60 Figure 2.2 Population growth and survival rate 61 Figure 2.3 The evolution of income per capita 62 Figure 3.1 Population pyramids, China (1964, 2000) 100 Figure 3.2 Population pyramids, China (2050) 101 vii Public policies on high fertility rates in developing countries: birth control, birth taxes or education subsidies? Abstract Developing countries typically have too many children and too little education. In this paper we consider two types of population policies: one through birth control as in China and the other through birth taxes. We find that both achieve the same equilibrium solution if tax revenue finances lump-sum transfers. By reducing fertility and promoting growth, these policies may achieve higher welfare than conventional education subsidies financed by income taxes. A birth tax for education subsidies can achieve the first-best solution. The welfare gain of the first-best policy may be equivalent to a massive 10-50% rise in income, depending on the degree of human capital externalities. Keywords: Fertility; Growth; Human capital externality; Welfare JEL classification: J13; O11; H23; I30 1. Introduction Owing to various factors such as human capital externalities in education, all countries in early development suffer from having too many children and too little education. Several types of public policies on education and fertility have emerged in the past several decades to tackle this problem for a better perspective of economic growth. From an economics perspective, we use a dynastic family model with human capital accumulation to consider two types of public policies on fertility in this paper: one through birth control as in China and the other through birth taxes. In addition to these population policies, we also consider conventional education subsidies financed by income taxes. We find that both types of population policies achieve the same equilibrium solution if birth tax revenue finances lump-sum transfers. By reducing fertility and promoting growth, these policies on fertility may achieve higher welfare than education subsidies financed by income taxes. Using a birth tax to subsidize education spending can achieve the first-best solution. Numerically, the welfare gain of implementing the first-best policy may be equivalent to a massive 10-50% rise in income for every generation, depending on the degree of human capital externalities. Numerous empirical studies of cross-country growth performance find that standards of living and economic growth are negatively associated with population growth; see e.g. Mankiw, Romer and Weil (1992) and Barro and Sala-i-Martin (1995). As a major contributor to population growth, the fertility rate varies significantly between rich and poor countries. According to the World Bank (2002), the average total fertility rate of 52 high-income countries, with a real GNI per capita above US$9,266 , is 1.7 children per woman in 2000, which is almost 20% lower than the replacement fertility rate of 2.1 children per woman. By contrast, the average fertility rate of 63 low-income countries, with a real GNI per capita below US$755, is 3.6 children per woman in 2000, which is 71% higher than the replacement rate. Also, there is much more state subsidization of persistent deficits since 1979. The central government may consider to make up the pension deficits simply by increasing contributions or by raising taxes. This works as wealth transfers from the current working population to current pensioners, which is difficult to be implemented in China since for both types of pension, less compliance exists. Encouraging the current working population to participate and be compliant to the shift of pension plans is not an easy task. Third, the second tier individual accounts were established as fully funded, but in reality, these accounts are virtually empty, as the funds have been redirected to the first tier social pooling account. This problem arises from the current funding shortfalls and from mismanagement of transition costs associated with the switch from PAYG to funded schemes. Another problem for the individual accounts is that the rate of return of investment is set administratively at relatively low rate by the government. This will lead to lower compliance to the second tier contributions. 3-2 The low coverage rate of the pension. Since the previous PAYG pension covered only state sector employees and also because the current pension system was newly established, the coverage rate of the system is very low. Currently, around 80 percent of the SOE’s/COE’s workers, 30 percent of other employees, and 20 percent of rural population are covered by the pension scheme. Government hopes that in 2010, all of the SOE/COE workers and 80 percent of other employees will be covered by the scheme, and the coverage rate of rural population will be 50 percent by then. However, for the rural pension participants, there is no financial support from the government. The core is a voluntary individual DC plan into the second tier 93 individual accounts, depends fully on private saving. Both the contribution level and the benefit level are very low due to the low income of rural peasants. For example, some of rural pension participants, aged from 12 to 50 years, may choose to contribute to 20 RenMiBi Yuan per month. They will receive a benefit of 50 Yuan when they reach the age of 60. Hence, beyond the low coverage rate, the very low level of pension benefits is another major concern. As more than half of the total population live in the rural areas, and most of them are still poor, expanding the new pension system to rural population will not be an easy task for the Chinese government. 3-3 Governance/institutional reform/implementation The proposed new pension system has basically two types of funding. One is the first tier social pooling (DB) and the other is the fully funded pension scheme (DC) for employees for the SOEs/COEs and other enterprises. With the new system, the social pooling has shifted the responsibility of each enterprise to a broader field, within the municipal pooling; and ultimately to the provincial level. However, currently in China, many municipalities had not been experienced in administering the social pooling funds; or they had not acquired advanced skills nor capacity to manage those funds. In the transition to shift to the funding pool, the separation of administrative control from financial obligations may induce moral hazard and compliance problems. Enterprises may under-report wages and the number of workers; employees may act less compliantly in participating the DC plan. This is due to the lack of legislations and governance on the responsibilities of both employers and pensioners, which calls for institutional reforms urgently in many areas. The government is weak in enforcement capacity 94 over enterprises; and needs to give incentives for enterprises and their employees to participate honestly in the system. There exists large scale of under-report of wages, several components of grey income and bonuses are excluded from the reported wages. Incentives should be given for full reporting of wages, such as allowing full deduction of wages in corporate income tax and permitting full deduction of contributions in personal tax. Lack of transparency in personal income reporting and governance; and lack of effectiveness of banking system are part of the reasons for the massive underreporting of wages. This again, is linked to issues of the institutional reforms in China. Financial market reform is another major concern. Even though the coverage for fully funded pension is not very high, the number of pensioners under such schemes will be considerably large, given the size of China’s elderly population. There will be a substantial amount of pension assets accumulated from the tier one and tier two contributions to the social pooling and individual accounts in the long run. To maximaize the investment returns of pension assets, the financial market in China needs to be further developed with more investment options available to pension funds. Currently, the investment of funds is mostly restricted to investing in government bonds and bank deposits. Another important component of the proposed new pension programs is the private saving from the tier three contributions to the individual accounts for the formal employees. Under the proposed system, the basic pension would provide an average benefit equal to 60 percent replacement ratio (20 percent tier one social 95 pooling and 40 percent tier two individual accounts). Therefore, individuals need to purchase additional voluntary pension from commercial life insurance companies4 to supplement the basic pension if they wish to secure a more than 60 percent replacement ratio. There will be increasing needs for individuals choosing to participate in funded financial assets that provide expected higher returns. This will require further opening up for the financial markets. Finally, the proposed new pension scheme has planned to be expanding to the other enterprises employees (including migrant workers), and rural population. And there is no specified plans released so far for these groups of population, government hopes to take the advantages of the experience obtained in Liaoning province in expanding the pension schemes. However, with the fast changing demography and rapid aging in China, this task becomes urgent for welfare concerns of the old age population, especially the rural old. The government may think to seek alternative ways in the pension reform towards rural population, in coordination with the Liaoning experiences. In sum, the prospects of funded pension plans depend crucially on how well the domestic financial market is developed, a reliable banking system is implemented; and whether well-organized regulating and monitoring institutions against investment risks are established, and how administrative costs are minimized. Transparency is a basis for active participation and effective communication. These are The China insurance market has been dominated by three domestic life insurance companies, the China Life, China Pacific Life and Ping An. With a controlled opening up of insurance market in mid-1990s, new licenses have been issued to both domestic and joint venture insurers. At the end of 1999, there was a total of five domestic life insurance companies (namely the China Life, China Pacific Life, Ping An, Tai Kang Life and New China Life) and five joint venture life insurance companies whose foreign partners are AIA, Manulife, Allianz, Aneta and AXA. It is expected that additional licenses will be granted to domestic and joint venture life insurance companies in the future. 96 true challenges for China, as it is in transition from a central-planned economy to a market-oriented economy with low average income level, to meet the requirements. The Chinese government needs to be prepared to the handling of the social security problem in a long run perspective, taking the experiences of industrialized countries into consideration while fitting with China’s own features of demography and pension system. However, for the existing pension schemes, PAYG or funded pensions, both are simply ways of dividing output between workers and pensioners, should not fare very differently in the face of demographic changes. The real security behind any pension plan is a wealthy and healthy economy. The crucial variable is output. Hence, the most challenging thing is trying to promote income growth so as to maintain the welfare needs of each generation of the entire population. 5. Conclusion With the changing demography, the population is aging fast in the industrialized countries and also in some of the developing countries. In order to finance the social security, many industrialized countries have implemented the PAYG pension system. However, as the aging process accelerates due to continuous decline in fertility, and improvements in health status, the PAYG pension is under the pressure of reform as it lowers saving and investment, and hence income growth. Many countries are making reform or considering to shift the unfunded PAYG pension to fully funded or partially funded pension systems. But the switch over from the PAYG to funded social security creates problems in the funding of pension schemes and takes generations to complete the transfer, which will result in both political concerns and economic implications on government policies. China is a special case, that on the one hand, it is facing a big challenge in trying to improve its economic progress as it is still a low income country; on the other hand, due 97 to drastic demographic transition, it is facing a rapid aging problem which is usually a problem for those wealthy countries. The social security system in China is well underdeveloped for its low coverage rate, and the funding of the pension. Although the Chinese government is trying to meet the pension needs of the elderly by reforming the pension system, the government has to face different challenges. Reforms in institutional instruments, legal legislations and financial markets are urgent concerns for China. 98 Table 3.1 Comparison of pace of aging in selected countries Country Japan France Netherlands Norway Sweden Switzerland U.S.A P.R. China Specific years attaining the percentage of the aged (as a share of total population) 7% 14% 1970 1865 1940 1885 1890 1935 1945 2000 1994 1980 2003 1978 1975 1985 2014 2027 Years required to double the aged share of population from 7% to 14% 24 115 65 93 85 50 69 27 Sources: A. Before 1940: United Nations, “The Aging of Population and its Economic and Social Implications”, Population Studies, No. 26, New York, 1956. B. After 1940: 1. United Nations, “World Population Perspects 1990”, Population Studies, No. 120, New York, 1991. 2. 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Health investment, saving and public policy. Canadian Journal of Economics 39, 68-93. 108 [...]... lump-sum transfers or as education subsidies We will compare the respective effects of these different population policies on education investment, fertility, economic growth and welfare Finally, we will compare all these population policies to a conventional education subsidy financed by income taxes 3.3 Birth control Consider a situation whereby the government sets an upper limit on the number of children... forgone from giving up vHt + qt units of consumption for one additional child is compensated by the marginal utility obtained from having this child Denote the fraction of income spent on consumption per capita as γc , and the fraction of income invested in a child’s education as γq , where γc = ct /[(1 − vnt )Ht ] and γq = qt /[(1 − vnt )Ht ], respectively In equilibrium, both fertility and proportional... both fertility and the fraction of income spent on consumption rise, but the fraction of income spent on each child’s education falls These consequences of the human capital externality conform to the stylized facts in less developed countries 10 It is thus interesting to consider government policies that affect parents’ decisions on fertility and education spending such that the gap between the competitive... introduces the model Section decline in fertility in the urban population but little change in fertility in the rural population which accounted for 80% of the total population In 1979, the government launched the birth control project, see Banister (1987) 5 three presents equilibrium solutions in various cases and derives the results Section four discusses policy implications, particularly for the... δHt+1 (23) In this condition, the subsidy rate reduces the cost of education investment proportionately (the LHS), while it reduces the benefit of education less than proportionately (the RHS) As a result, the education subsidy tends to raise education investment 17 The first-order condition with respect to fertility is: vHt + (1 − s)qt + θ(nt − ntax )θ−1 Tt ρ = ct nt (24) In this condition, the birth tax... motivates our use of the logarithmic utility function, beyond its benefit of keeping the model tractable, because a more general utility function would likely link the level of fertility to the conventional education subsidy financed by income taxes Further, as expected, the education subsidy induces parents to spend less on consumption and more on children’s education: S γc = (1 − s)[1 − αβ(1 − δ) − αδ] , (1... to the birth tax scenario, this condition implies that, the subsidy rate reduces the cost of education investment proportionately (the LHS), while it reduces the benefit of 22 education less than proportionately (the RHS) As a result, the education subsidy tends to increase the return on education investment, and hence raises education investment The first-order condition with respect to the number of... per capita, is higher in the social planner’s solution than in the competitive solution This can be seen as follows Comparing the competitive solution in (7)-(9) with the social optimum in (12)-(14), both fertility and the fraction of output spent on consumption are higher but the fraction of output spent on education is lower in the former solution than in the latter Intuitively, in the presence of... parents to spend more on education and less on consumption Because of this, the birth tax for education subsidies is expected to have a positive effect on the growth rate of income Both the decline in fertility and the rise in education investment, caused by the birth tax for education subsidies, help to narrow the gaps between the competitive solution and the social planner’s solution, in the presence... focus on how an education subsidy financed by income taxes affects fertility and education investment, without taking the human capital externality into account and without considering the welfare consequence Here, with the human capital externality we will also consider how 19 such a policy affects welfare and make a welfare comparison between this conventional policy and the various forms of population . intergenerational transfers – the 63 pension needs of an elderly society: the case of China Bibliography 102 iii SUMMARY This dissertation contains three essays on population economics. . THREE ESSAYS ON POPULATION ECONOMICS SHI YUHUA (M.Soc.Sci., NUS) A THESIS SUBMITTED FOR THE DEGREE OFDOCTOR OF PHILOSOPHY DEPARTMENT OF ECONOMICS NATIONAL UNIVERSITY. economics. The first essay focuses on the welfare comparisons of different population policy options. With special concern on China’s “one-child” population policy, we propose an alternative