College Aid & Intergenerational Mobility

The paper begins by establishing the rationale for government intervention in higher education, primarily focusing on capital market imperfections and borrowing constraints. Because human capital is difficult to use as collateral for loans, many individuals face financial barriers to accessing college, particularly those from low-income families. This limitation directly inhibits intergenerational mobility, preventing individuals from escaping the socioeconomic status of their parents. The study acknowledges that while K-12 education may have externalities (socialization, democratic participation, crime reduction), these arguments are less applicable to higher education. To analyze the problem, a dynamic general equilibrium model is developed. Key features of this model include endogenously determined bequests from parents, uncertainty in college completion linked to individual ability differences, and wage determination influenced by the overall level of education in the economy. The model's design is crucial because college subsidy policies greatly affect educational attainment, thereby directly influencing wage levels in a general equilibrium context.

The research analyzes four main types of college education subsidies: tuition subsidies (similar to those prevalent in public colleges in the U.S.), need-based aid, merit-based aid, and income-contingent loans. Each subsidy type is designed to address the issue of borrowing constraints limiting access to higher education and improving economic efficiency. While all these schemes show potential to improve economic output and intergenerational mobility, compared to a scenario without government intervention, their impacts differ significantly. Need-based policies generally lead to substantially greater income equality than merit-based programs. Uniform tuition reductions, a common approach in many higher education systems, prove less effective in achieving the objectives compared to more targeted need-based approaches. Income-contingent loans, although conceptually appealing, can result in high-ability, low-income individuals essentially subsidizing others, due to natural adverse selection.

The model is calibrated to match key features of the U.S. college and labor markets. In the absence of government intervention, a significant portion of the population (8%) is found to be capital constrained—meaning they would attend college if they could afford it. This constraint leads to an overall economic efficiency loss of 4.7%. This highlights the substantial inefficiencies resulting from limited access to higher education. The analysis of different subsidy schemes emphasizes the general equilibrium effects. Each intervention changes the distribution of skilled and unskilled workers, directly impacting wages. The study finds that while each subsidy scheme improves economic efficiency, the distribution of benefits and costs differs greatly. Need-based programs are shown to significantly improve income equality, while merit-based programs have less positive distributional effects. Income contingent loans, while initially appearing attractive, are shown to present unique challenges related to adverse selection and potentially regressive effects.

The research assesses the aggregate outcomes of the different subsidy policies, considering their effects on economic efficiency, income distribution, and intergenerational mobility. All subsidy schemes improve economic efficiency by reducing the number of capital-constrained students. However, the degree of improvement and the associated distributional consequences vary considerably. Need-based aid consistently yields higher levels of income equality than merit-based or uniform tuition reductions. The study employs the Gini coefficient and Aggregate Expected Utility to quantify these effects. Regarding intergenerational mobility, all subsidy schemes improve the chances of a child obtaining a college education irrespective of their parents' educational background. The rate of this improvement, though, varies among the different types of subsidies explored. A crucial finding is the importance of considering general equilibrium effects: changes in wages and overall economic performance significantly influence the success of different subsidy policies. High-ability, initially unconstrained individuals may even experience net losses due to increased taxes and wage reductions under some subsidy schemes. The study's findings emphasize the nuanced tradeoffs between economic efficiency and equitable distribution of resources, highlighting that targeted and well-designed policies are vital to achieve optimal outcomes.

The core of the model is a two-period life cycle framework. In the first period, individuals make decisions about their education, and in the second period, they work and potentially provide bequests to their children. Crucially, the model incorporates capital market imperfections. Individuals cannot borrow against their future earnings to finance their education; their only source of funding is parental bequests. This feature of limited access to borrowing is a key element of the model reflecting the reality of borrowing constraints experienced by many students. The size of the bequest directly affects a student's ability to attend college. The inability to borrow against future earnings highlights a fundamental market failure and creates substantial inequality in access to higher education. Wages are determined by an individual's educational attainment (college completion or not) and inherent ability. This design introduces realistic elements to a stylized representation of the economic dynamics involved in higher education.

Individual ability plays a central role in the model. It influences both the probability of successfully completing college and the subsequent level of labor market productivity. This introduction of inherent ability creates uncertainty because students face a risk of not completing their education even if they enroll. The probability of success in college is directly proportional to the individual's ability level. Families must fully fund their children's education, which means that if parental bequests fall short of tuition costs, the child is prevented from attending college, regardless of their ability. This inherent randomness in outcomes, combined with the financial constraints imposed by the model, creates a complex interplay of factors influencing access to and success in higher education, underscoring the fact that many capable individuals may be prevented from pursuing higher education because of financial constraints.

The model is calibrated to reflect key aspects of the U.S. labor and college markets. With no government intervention, the model demonstrates substantial inefficiencies caused by the limited access to borrowing against future earnings. A significant percentage of individuals (8%) are identified as capital constrained, meaning they would pursue higher education if they had sufficient financial resources. This demonstrates the scale of the market failure the study aims to address. The high rate of capital constraint also leads to a high college failure rate (25%), as lower ability students who would otherwise not have pursued higher education are able to enroll due to some level of financial resources. The overall economic efficiency loss due to the constraints imposed by capital market imperfections is estimated at 4.7%, emphasizing the significant cost associated with this limitation in education access. This baseline model serves to quantify the magnitude of the inefficiency and motivates the exploration of alternative government intervention strategies.

The analysis begins by examining the impact of a flat tuition subsidy, a common approach in many public college systems. The researchers consider a scenario where parental bequests are not perfectly observable to the government, leading to imperfect information. While a flat subsidy can increase college enrollment, the threshold levels of bequest and ability for college attendance are affected by the parent’s education level, which may not perfectly align with their actual financial capacity. Even with this uniform subsidy, some students remain constrained by insufficient parental resources. This scenario highlights the tradeoffs inherent in blanket approaches to college financial aid, illustrating that even uniform tuition reduction may not solve the issues created by incomplete access to capital markets and uneven distribution of family resources, especially as the policy may be less effective for children with uneducated parents.

Next, the study investigates need-based grants, a more targeted approach to financial aid. The model assumes that the government can observe parental wealth and target subsidies accordingly. This policy is designed to assist students from financially constrained backgrounds. The analysis indicates that need-based policies increase college enrollment rates significantly, but it also comes at a cost. While boosting overall enrollment, this approach also leads to an increase in the number of students who do not successfully complete their college education, highlighting the importance of careful policy design even in targeted aid programs. While this approach yields greater income equality than merit-based policies, there is still an issue of efficiency loss, suggesting that a pure need-based approach may not perfectly align with maximizing social welfare.

The paper explores the use of income-contingent loans (ICLs), where repayment is tied to future income. This approach is theoretically appealing as it aims to remove borrowing constraints entirely. However, the model demonstrates the potential for adverse selection. High-ability, low-income individuals effectively end up subsidizing less-capable students, creating an unintended distributional effect, and challenging the equity objectives. The model also highlights that a completely unrestricted ICL system is not viable; it would incentivize even low-ability individuals to attend college due to low opportunity costs, resulting in an unsustainable system. The analysis suggests that the parameters of the ICL program (such as eligibility and repayment rates) require carefully consideration. Without opportunity costs, this policy risks inefficient allocation of resources despite its potentially high impact on social mobility and improving educational access.

Finally, the research examines merit-based aid, where financial assistance is allocated based on student ability or performance. The model assumes perfect observability of ability, which simplifies the analysis but is not reflective of real-world scenarios. In practice, some proxy measure would need to be implemented. While merit-based aid may incentivize academic achievement and reward high-ability students, the distributional implications of this approach can be problematic, resulting in reduced income equality compared to need-based alternatives. The study implicitly acknowledges the real-world challenges of accurate ability measurement, noting that the reliance on proxies may result in different outcomes and exacerbate existing inequalities, making it a less efficient approach than targeted need-based strategies.