Credit market imperfections are pervasive in the case of education loans, partly due to the fact that, since human capital does not act as collateral for loans, there is a moral hazard problem in loans to finance education. For example, Lazear (1980) and Jacoby and Skoufias (1997) find strong links between financial market imperfections and human capital accumulation in the context of USA. We concentrate on the implications of credit market imperfections for education, assuming no failure in the credit market for financing the purchase of physical capital.
Those with the least resistance (highest ability) will usually borrow when they are young to get an education and earn a qualifying wage in another period when they use up and repay the loan. Skilled labor complements capital, as an increase in the employment of skilled workers raises the marginal product of capital. We are aware that there is no comparable discussion of the reasons for government intervention in education in the existing literature.
In Section 2 we present the basic model, and in Section 3 we analyze the steady-state equilibrium without credit constraints. An agent born at time t-1 can train to become a skilled worker in the next period (t) and receive a wage wH,t, which is used to repay the loan at the real interest rate rt and for consumption.
CREDIT CONSTRAINED EQUILIBRIUM
In the steady state, a credit-constrained economy is associated with a lower level of education, a higher capital-labor ratio, a lower real interest rate, and a higher skill wage rate than its absence. By Pareto inefficiency we mean that a relaxation of the ICC would allow everyone to be better off in the presence of lump sum taxes and transfers. The Pareto inefficiency of the constrained equilibrium is not surprising, since credit constraints limit some agents' opportunities to be educated regardless of their desire.
That credit constraints mean a lower real interest rate is confirmed by Azariadis and Smith (1993), although the underlying mechanism is different. In their pure trade model, credit constraints caused by adverse selection increase savings and thus lower the real interest rate. Those who can still borrow to buy an education benefit from credit constraints in two ways: the qualified wage rises and the real interest rate falls.
In contrast, in models with an exogenous real interest rate, the spillover effect of credit constraints via the back channel is absent. Proposition 2: (Inequality) The presence of credit constraints widens inequality between the skilled and the unskilled. The non-degenerate bounded steady-state equilibrium of credit possesses the following properties: i) an average conservation spread of the education disuse cost distribution (ie, a larger one) encourages education and discourages capital accumulation; . ii) an increase in the productivity (wage) of the unskilled (v) increases both the capital-labor ratio and the level of education;. iii) an increase in the cost of education in money (2) reduces the percentage of the educated population and has an ambiguous effect on the capital-labour ratio; iv) an increase in the cost of flight (B) increases the proportion of the educated population and lowers the capital-labour ratio.
An increase in the productivity/wage of the unskilled (v) does not affect the CC locus, but does shift the EE locus outwards. The effect of an increase in the monetary cost of education (2) on x is negative, while its effect on k can. Comparing the constrained and unconstrained equilibria, one can easily see that credit constraints result in a lower level of education, a higher capital-labor ratio, a lower real interest rate, and a higher skilled wage in the steady state, as in the measure. model.
The steady-state response of education to changes in the economic cost of education and the effect of a change in the cost of attrition remain qualitatively unchanged.
PUBLIC POLICY
In the social optimum, the government chooses x to maximize (14), subject to the government's budget constraint and the resource constraint (ie, the EE locus). Because of the imperfection of the credit market, the level of education in this steady state is lower than in the unconstrained equilibrium. The government decides on the level of education xN (the new stationary values of the variables are denoted by prime numbers).
Since the same equation as before applies to the EE curve, we conclude that the optimal policy for the government is to restore the unbounded equilibrium levels of x and k. It can be noted that this does not now restore the unbounded equilibrium levels of consumption for the two groups .). This gives the same value of SWF as in the unconstrained equilibrium, so it appears that it does not matter how the government finances its spending, provided it succeeds in getting the economy back to the unconstrained equilibrium. But if public education is financed this way, educated workers will be better off (since they pay no taxes and repay no education loans) and uneducated workers worse off (since they are now taxed) than in the unconstrained equilibrium.
So far we have assumed that the government can ensure that the uneducated pay their taxes and are not subject to the kinds of restrictions they face in taxing the educated (or, if they are, not binding at best). But even if such a constraint binds and prevents the achievement of the optimum, the government should be able to improve the constrained equilibrium by taxing both the educated and the uneducated. We can show that the government must be able to mimic an unbounded equilibrium if it has no problem taxing the educated, and this is optimal.
We are therefore led to consider an education subsidy financed by a tax on the uneducated and, again, as before, we can show that the government can restore the unbounded equilibrium values of x and k (and this is optimal). There is still rationing of education, but it is rationing enforced by the borrower, not by the government. Thus, if the government cannot finance a subsidy to education that restores the unbounded equilibrium by taxing the educated, it may be able to do so by taxing the uneducated; it can achieve the same level of social welfare as in the unconstrained equilibrium.
Alternatively, suppose the same level of education is offered by the private sector subsidized by the government. The idea is that the government selects those with the lowest disutility cost of education to be educated; the private sector selects those with the greatest chance of repayment. Our analysis suggests a possibility that the government may be able to ensure that education is distributed more efficiently among the population than the private sector.
CONCLUSION
In the absence of market imperfections or distortions, the proof of the property that the unconstrained equilibrium is Pareto efficient is standard. Then he is better off, and since the same amount of output is produced in the rest of the economy, general transfers and taxes can ensure that no one is worse off. However, the constrained equilibrium is not Pareto comparable to the unconstrained equilibrium because those who remain skilled are better off, while those who remain unskilled are worse off under credit constraints.
Proof of Proposition 4: The first part of the proposition about the possibility of both types of education subsidies to restore the unconstrained equilibrium has been proved in the text. To perform Pareto ranking, we distinguish between three types of agents: (i) (type-H) initially trained under credit constraints and still trained with subsidies; (ii) (type-M) initially unskilled under credit constraints and skilled with subsidy; and (iii) (type-L) initially unskilled under credit constraints and still unskilled with subsidies. Since type-M funds are better off than type-L funds in the new equilibrium (by the revealed preference argument) but equally well-off in the old equilibrium, it is sufficient to establish the result by showing that both type- H and type L funds are better off in the new equilibrium.
There is also evidence of the importance of credit constraints on lending to entrepreneurs (Evans and Jovanovic 1989) and to households (Japelli and Pagano 1994). None of these papers allow for an endogenous choice between borrowing and lending, which plays an important role in generating some of our main results, and there is no comparable discussion of the public policy implications of credit constraints. Aghion and Bolton (1997) have an endogenous choice between becoming a borrower or a lender in a model where agents differ in initial wealth and physical investment loans are subject to credit constraints.
They mainly consider the spillover effect of physical capital accumulation when credit constraints support persistent income inequalities. We have a parameter that measures the cost of default, and when we discuss "the consequences of credit constraints," what we really mean is "the consequences of reducing the cost of default parameter." It is also worth noting that this assumption is required to bring out credit constraints (see Section 4 below); it can be weakened if we allow the unskilled and defaulters (who borrow but do not invest in education) to earn in the second period of their life.
If there is no interest rate at which this happens, then there is no lending - a rather extreme case of credit constraints. In the case where capital and unskilled labor are complementary, the marginal product of capital effect tends to increase the real interest rate. However, the negative effect of credit constraints on the real interest rate remains as long as its effect on the unskilled wage dominates that on the marginal product of capital.
Young
Educational Choice
Receive Principal Work as Skilled
Repay Education Loanand Interest Earn Skilled Wage
CNN CCNN
