Status Externalities and Low Birth Rates in Korea

South Korea has been experiencing a very low total fertility rate around 1.2 over the last two decades. A serious concern of the Korean government about low fertility is demonstrated by its billions-dollars worth spending in recent years. In this paper, we aim to understand why the birth rate is so low in Korea and to assess whether there is a reason for the government to be concerned. We ask what, if anything, could and should be done about the low fertility rate. To do so, we propose status externalities as a new reason for inefficiently low fertility. In our model with endogenous fertility, parents care about the education of their children relative to other parent’s children. We find that the equilibrium is characterized by over-investment in education and under-investment in fertility, relative to the first best. We calibrate the model to Korean data to quantify the role of the status externality. We find that without it fertility would be 17% higher. We also find the externality plays a large role in explaining the fertility-income relationship, which is positive in Korea, in contrast to most other countries. We conduct several policy experiment and find that taxing education would not be desirable in welfare terms, even though it reduces the over-investment. Similarly, pronatal transfers do increase the fertility rate but are also not welfare improving. We conclude that more subtle policies are needed to rectify the friction introduced through status concerns.