Human Capital Investment and Debt Constraints

David Andolfatto () and Martin Gervais ()

Review of Economic Dynamics, 2006, vol. 9, issue 1, pages 52-67

Abstract: When young individuals face binding debt constraints, their human capital investments will be insufficiently financed by private creditors. If generations overlap, then a well-designed fiscal policy may be able to improve human capital investments by replacing missing capital markets with an intergenerational transfer scheme. The optimal (balanced budget) fiscal policy in this context entails the joint provision of an education subsidy for the young and a pension program for the old, financed with a tax on those in their peak earning years. We demonstrate, however, that the desirability of such a cradle-to-grave policy depends crucially on the assumption of an exogenous debt constraint. If debt constraints arise endogenously for reasons of limited commitment, then the optimal (balanced budget) fiscal policy looks radically different. Furthermore, we find that cradle-to-grave type policy interventions may actually lead to lower levels of human capital investment as altered default incentives induce private creditors to contract the supply of student loans by an amount greater than the subsidy. In some cases, the constrained-optimal policy entails zero intervention. These results highlight the importance of taking seriously the reasons for why debt constraints exist. (Copyright: Elsevier)

Keywords: Education; Fiscal policy; Debt constraints (search for similar items in EconPapers)
JEL-codes: E62 H52 I28 J24 (search for similar items in EconPapers)
Date: 2006
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