CHILDREN AS AN INVESTMENT: New evidence on the links between income, intergenerational transfers and parents” fertility choices

Because parents can''t legally impose any debt obligations on their children for their upbringing, fertility rates are significantly lower than their potential. That is the argument made by Juan Carlos Cordoba and Marla Ripoll in research published in the June 2016 Economic Journal.

Their calculations of the costs of childrearing as well as the present value of a child''s total future income suggest that children are on average a potentially sound investment for parents. But limits on ''intergenerational transfers'' mean that parents have far fewer children than might be expected.

Imagine a situation, the researchers begin, in which the present value of a child''s future income exceeds the costs of raising the child. If altruistic parents could borrow on behalf of a child, say to cover rearing costs, then the child will be born and will reach his or her potential. But in this case, it would also be profitable for parents to have as many children as possible regardless of their income.

This was actually not very far from reality in the United States prior to 1850 when parents had legal access to their children''s income. Since then, parents have gradually lost the legal right to own or borrow against their children''s income, and they have legal obligations to provide appropriate care to their children. Parents cannot impose any debts on their children for their upbringing.

The new study shows that such constraints on intergenerational transfers can explain why fertility rates are significantly lower than their potential – and why fertility rates are negatively related to income, falling as income rises. These are both indicative of ''market frictions'' affecting family choices and ultimate individual outcomes.

Consider a child born in 2011 to a low-income family of two adults and two children in the United States. According to the US Department of Agriculture, the average cost of raising the child from age 0 to 17 is $148,962. This includes direct parental expenses such as housing, food, transport, healthcare, clothing, childcare and private expenses in education.

Parents also incur time costs in raising the child. The researchers estimate this time cost to be between $223,443 and $446,886. Therefore, the total cost of raising a child in a low-income family is between $372,405 and $595,848.

In addition, the researchers estimate that the present value of the total future income of this child would be around $661,529. These figures show that children are on average a potentially sound investment for parents. But the observed low fertility rates suggest that parents have limited ability to access their children''s income, offering prima facie evidence for the existence of operational constraints to intergenerational transfers.

Such market frictions can also explain the negative fertility-income relationship documented across countries and time, and also across families within countries. In the absence of constraints on intergenerational transfers, fertility would be independent of parental income. But in the presence of these constraints, the researchers show that fertility declines with parental income as long as parents'' own consumption is a luxury good.

This occurs when as parental income increases, altruistic parents care more about saving and smoothing their own consumption over the life cycle, rather than having more children and smoothing consumption across family members. The researchers conclude that learning about fertility choices can change the way we think about market frictions in macroeconomics in a fundamental way.

''Intergenerational Transfers and the Fertility-Income Relationship'' by Juan Carlos Cordoba and Marla Ripoll is published in the June 2016 issue of the Economic Journal. Juan Carlos Cordoba is at Iowa State University. Marla Ripoll is at the University of Pittsburgh.