Parents influence their children through genetic inheritance but also by the time and financial resources dedicated to them. While genes are hard to change, resources may vary over time. The main question addressed in this paper is the following: how well do parents shield children from fluctuations in family resources? This involves understanding whether time investments and goods expenditures in children change substantially with income shocks; whether the effects on child specific expenditures are different than effects on nondurable consumption; and whether income shocks are transferred to a child’s human capital.
Understanding how parental investments in children respond to income shocks is important because parents may face imperfect insurance against shocks. Furthermore, if imperfect insurance is coupled with a technology of skill formation where the timing of investments matters (Cunha and Heckman, 2007), then income shocks at the beginning of a child’s life can have irreversible effects on her human capital. Therefore, learning about households’ reaction to shocks is informative for the design of policies targeting more disadvantaged families with young children.
Although there has been work documenting the relation between changes in income distributions and consumption, and substantial evidence on differences in the educational attainment of children from different socioeconomic backgrounds, there are virtually no studies on the effects of changes in income on parental investments in children. One of the reasons for this gap in the literature is the lack of data sets that comprise simultaneously information on family income and use of financial and time resources (respectively, consumption and time use) and measures of human capital at several stages if a child’s development. In this sense, this paper has a dual contribution for the literature: (1) it evaluates the degree of insurance of parents with respect to investments in their children’s future, and (2) presents a practical method to combine three widely used American data sets: the National Longitudinal Survey of the Youth 1979 (NLSY79), the Consumer Expenditure Survey (CEX) and the American Time Use Survey (ATUS).
The role of imperfect insurance is well studied in the literature on consumption5, but the addition of parental investments in children to the model poses new challenges. First, investment decisions have important dynamic implications. Parents are forward looking and anticipate the effects of the allocation of time and expenditures on their children adult behaviors and human capital; childhood experiences accumulate over the life cycle and evolve into skills, work habits, or engagement in risky behaviors when individuals reach adulthood. The relevant theoretical model has features of a life-cycle model of consumption with nonseparability of utility over time, such as in models with habit persistence and durable goods. Those investments that are complements over time have characteristics of habit persistence; investments that are substitutes have characteristics of durable goods (see Heaton, 1993, Cunha and Heckman, 2007).
