Mental Health and Human Capital Composition in a Dynastic OLG Model with PAYG Pensions

TL;DR

This paper presents a dynastic OLG model incorporating mental health as a key human capital component, analyzing how PAYG pension policies influence fertility and investment in various human capital dimensions.

Contribution

It introduces a novel modeling of mental health as an independent productivity input and examines its implications for pension policy and human capital composition.

Findings

Higher pension contributions increase fertility but reduce investments in all human capital dimensions.

Greater mental health elasticity shifts resources toward non-cognitive skills and decreases fertility.

Pension systems relying on children for old-age security can hinder long-term human capital development.

Abstract

This paper develops a two-period dynastic overlapping-generations (OLG) model in which parents simultaneously choose consumption, savings, fertility, and three distinct dimensions of child quality-education, physical health, and mental health-under a pay-as-you-go (PAYG) pension system. The central innovation is modelling mental health as an independent productivity-enhancing input with its own elasticity $\theta$ in a Cobb-Douglas human-capital technology. This yields simple proportional allocation rules and shows how pension policy affects not only the overall level but also the composition of human capital investments. In steady state, higher PAYG contribution rates raise fertility through the Yakita effect but crowd out per-child investments in all quality dimensions, including mental health. An increase in the mental-health elasticity $\theta$ shifts resources toward non-cognitive skill development while reducing fertility. These results reveal a fundamental policy tension for developing economies: pension systems that rely on children for old-age support simultaneously increase birth rates while reducing long-term human capital formation, with disproportionate effects on non-cognitive skills. The framework provides theoretical guidance for complementary policies that protect mental-health investments, with particular relevance for countries such as India where children remain a primary source of retirement security and mental-health services are underfunded.