Abstract
We study the social, demographic and economic origins of social security. The data for the U.S. and for a cross section of countries suggest that urbanization and industrialization are associated with the rise of social insurance. We describe an OLG model in which demographics, technology, and social security are linked together in a political economy equilibrium. In the model economy, there are two locations (sectors), the farm (agricultural) and the city (industrial) and the decision to migrate from rural to urban locations is endogenous and linked to productivity differences between the two locations and survival probabilities. Farmers rely on land inheritance for their old age and do not support a pay-as-you-go social security system. With structural change, people migrate to the city, the land loses its importance and support for social security arises. We show that a calibrated version of this economy, where social security taxes are determined by majority voting, is consistent with the historical transformation in the United States.
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Notes
Appendix A provides data sources for all figures and tables.
On the macroeconomic effects of Great Depression, see Cole and Ohanian (2004).
Hansen and Prescott (2002) model the industrial revolution as a switch from a (Malthus) production technology with a fixed factor of production, land, to a (Solow) production technology, with no fixed factors. Parente and Prescott (2005) use a similar framework to study the evolution of international income levels since 1750. Galor and Weil (2000) provides a framework in which transition from stagnation to growth occurs endogenously within a unified framework. Laitner (2000) studies a two-good, two-sector model in which, like Hansen and Prescott (2002), only the agricultural sector uses land. He investigates why the savings rate increases with development. Other well-known models of structural change are Echevarria (1997) and Kongsamut et al. (2001). Greenwood and Seshadri (2002) and Gollin et al. (2002) model the shift of labor from agriculture to manufacturing, and the associated pattern of rural to urban migration that is associated with process of economic development.
Doepke and Zilibotti (2005) study how skilled bias technological progress, which lowers fertility and increases the importance of education, can lead to the adoption of child labor laws. Galor and Moav (2006) show that it might be in capitalists’ own interest to expand public education to the masses as a result of the growing importance of human capital for the production process. Doepke and Tertilt (2009) show that the growing importance of human capital can also trigger men to grant political rights to women. Galor et al. (2009) study the effects of the concentration of land ownership on human capital accumulation and growth within a political economy model. Bertocchi (2011) studies the long run decline in the importance of bequest taxes within a two-sector (agriculture and manufacturing) dynamic political economy model. In her model, land is easier to tax than capital. The decline of agriculture, which reduces the value of land, makes bequest taxes an unattractive option over time.
There also exists a large literature that analyzes macroeconomic and distributional implications of the current social security system without political economy considerations (e.g. Imrohoroglu et al. 1985).
Cooley and Soares (1999), Galasso (1999), and Boldrin and Rustichini (2000) build models in which non-altruistic median voters decide to keep an existing system. The median voter’s decision depends on two factors in these models: First, there exists a reputational mechanism in place which eliminates all future benefits if the median voter deviates from the current arrangement. Therefore, a median voter cannot avoid taxes today and hope to get benefits in the future. Second, the median voter might want to keep an existing social security system in order to benefit from the high interest rates associated with a depressed capital stock.
For example, Cooley and Soares (1996) study an economy in which the initial generation votes over a social security replacement rule that depends on the age structure of the population. Hence, as the population structure changes (e.g. as a result of the Baby Boom) a rule that was sustainable in the past can become unsustainable. Gonzalez-Eiras and Niepelt (2005) link the size of intergenerational transfers to the age structure of the population. Conesa and Krueger (1999) study how the status-quo bias is related to idiosyncratic uncertainty.
Krueger and Kubler (2005) study how the introduction of an unfunded social security system can be Pareto improving in an economy with incomplete markets.
In his study of Butler County (Ohio), Newell (1986) documents that for the 1803–1865 period, inheritance consisted almost exclusively of real property.
Even at the end of the 19th Century, most farmers were owners, see Barlowe and Timmons (1950).
As (Sass (1997), p. 5) points out “The family enterprise institution also vested the old with powerful property rights vis-a-vis their adult children. Elderly parents held first claim on the firm and its assets, while their offspring remained dependent for their incomes and inheritance...parents retained ownership over the main body of family assets and chose when they would transfer farms and businesses to their children.”
This was true even for financially developed cities like New York. “Most early New Yorkers did not have a bank account. In 1825 New York contained about 60,000 people per solvent commercial bank. By 1835 this number had dropped to about 26,000. But even in 1855, when New York had 11,000 people per bank, ...it is clear fairly large segments of the population did not have direct dealings with New York Banks” (Wright 2001, p. 114).
According to (Wang (2008), p. 446): “Namely, farmers and artisans did not have easy access to banks. They usually borrowed in the personal credit market.” (p. 446). “Thus despite a well-developed market, most potential borrowers in Massachusetts did not have access to bank credit.” (p. 456).
We therefore abstract from the rise in retirement (i.e. decline in the labor force participation of old) since the 1850s. See Kopecky (2011) for a model with endogenous retirement that links this rise to the technological progress in the production of leisure goods.
Online Appendix C contains the degree to which we can analytically order preferred tax levels by voter age and location.
If the return to social security is less than the return to capital, no middle-aged person, and as we will show in the next section, no young person will choose a positive tax level. As a result, how the asset choice changes with the tax level is not relevant when \(\frac{2}{\pi }<1+r.\)
We assume that an individual can only choose a non-negative tax level. We discuss the possibility of negative social security taxes in online Appendix E.
Indeed, the effects of an increase in longevity are not obvious. Land is a fixed factor on the farm, so increasing survival probabilities reduces farm wages, but also increases the return to land. This crowding of land could encourage young farmers to migrate to the city. With higher life expectancy one also waits longer to inherit land, but is more likely to survive to old age. Whether an increase in life expectancy leads to migration is a quantitative question, which we explore in Sect. 5.
See Sect. 5.2.2 for an example of when price movements cause middle-aged-landless farmers to support social security.
From another point of view, the introduction of the social security might lower fertility as parents are less likely to have children to care for their old age—Boldrin et al. (2005).
The reputational mechanism we use follows the standard political economy approach in the literature (see Cooley and Soares 1999; Galasso 1999, and Boldrin and Rustichini 2000). Two early papers that emphasized the political sustainability of social security were Browning (1975) and Sjoblom (1985). In the current analysis we focus on taxes that maximize the lifetime utility of the median voter, although there can be many constant tax levels that are sustainable under the reputational mechanism we have just described.
The value for capital share in the city (industrial) technology, \(\theta =0.4,\) is the standard value for the postwar U.S. economy. The labor share is assumed to be the same for both sectors, \(\mu =1-\theta =0.6.\) Finally, \(\phi =0.1\) is picked to be consistent with historical evidence on agricultural incomes. See Hansen and Prescott (2002) for details.
Let \(P_{i}\) be the size of age-\(i\) population. We have data on \(P_{60-64},\,P_{65-69},\,P_{70-74},\,P_{75-80}\) and \(P_{80+}\) in 1850, and on \(P_{60},P_{65},\ldots ,P_{80}\) in 1940. For 1850, we calculate \(\pi \) as
$$\begin{aligned} \pi =\frac{(P_{60-64}+P_{65-69}+P_{70-74}+P_{75-80}+P_{80+})/4}{P_{60-64}}, \end{aligned}$$which captures an average survival rate. The calculations for 1940 are done in a similar way.
Doepke and Zilibotti (2008) contrast relatively flat wage profiles of agricultural workers and land owners with steep wage profiles of entrepreneurs in the 19th century. They model the emergence of capitalism within a model of structural transformation in which entrepreneurs influence their children’s preferences in an attempt to make them more patient.
When social security was introduced the total (employee plus employer) tax rate was about 2 %, which has gradually increased to its current level of 15.3 %.
Only 2 to 4 % of elderly owned private annuities between the 1930s and the 1980s according to Warshawsky (1988).
See the large literature starting with Imrohoroglu et al. (1985).
In order to keep the computational analysis simple we assume that this leak is returns that are not transferred to farmers (not a leakage on actual capital). It is lost after the production take place.
Perotti and Schwienbacher (2009) study how large inflationary shocks in the first half of the XX century, which devastated middle class savings in some countries, affected their reliance on state versus market institutions.
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Acknowledgments
We thank Oded Galor (Editor), three anonymous referees, Jeff Campbell, Dirk Krueger, Per Krusell, Lance Lochner, Stephane Pallage, and seminar and conference participants at Canadian Macro Study Group Meetings in Montreal, CEMFI, CEPR Annual Public Policy Symposium in Kiel, Federal Reserve Bank of Chicago, Federal Reserve Bank of Cleveland, Indiana University, REDg General Equilibrium Macroeconomics Workshop in Santiago de Compostela, Society for Economic Dynamics Meetings in Prague, Universitat Pompeu Fabra and University of Rochester for comments. Guner acknowledges financial support from Spanish Ministry of Economy and Competitiveness, Grant ECO2011-28822.
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Appendix A: Data sources
Appendix A: Data sources
Figure 1: Hernandez (1996), Table 4.
Figure 2: The urbanization rates are from the 1930 Census, Table 6, page 10, available at http://www2.census.gov/prod2/decennial/documents/16440598v2_TOC.pdf. The elderly population is calculated from Hobbs and Stoops (2002), Table 7, page A-19. The dates for state old age assistance laws are taken from ElderWed, http://www.elderweb.com/home/node/2896.
Figure 3: The fraction of the labor force in agriculture is based on Mitchell (2003), Table B1 Economically Active Population, by Major Industrial Groups, page 147. The adoption of social security dates are from the Social Security Administration (2006).
Figure 4: Greenwood and Uysal (2005), Figure 9.
Figure 5: The data for 1850 and 1900 are from Haines (1998) and for 1950 are taken from the U.S. Department of Health, Education and Welfare (1964). They are the average of the conditional survival probabilities from age 60 to 65, from 65 to 70, from 70 to 75 and 75 to 80. The 1850 numbers are for white males only.
Table I: GDP per capita is taken from Carter et al. (2006), Table Ca9-19, Loans and Discounts of Banks is from Carter et al. (2006), Table Cj149-157, the U.S. population, which is used to calculate per capita loans and discounts is from Carter et al. (2006), Table Ca9-19. The information on maturities is from Hammond (1934), page 89.
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Caucutt, E.M., Cooley, T.F. & Guner, N. The farm, the city, and the emergence of social security. J Econ Growth 18, 1–32 (2013). https://doi.org/10.1007/s10887-012-9086-5
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DOI: https://doi.org/10.1007/s10887-012-9086-5