Education Policy and Intergenerational Transfers in Equilibrium

By Brant Abbott, Giovanni Gallipoli, Costas Meghir and Giovanni Violante

http://d.repec.org/n?u=RePEc:cwl:cwldpp:1887r&r=dge

This paper examines the equilibrium effects of alternative financial aid policies intended to promote college participation. We build an overlapping generations life-cycle, heterogeneous-agent, incomplete-markets model with education, labor supply, and consumption/saving decisions. Driven by both altruism and paternalism, parents make inter vivos transfers to their children. Both cognitive and non-cognitive skills determine the non-pecuniary cost of schooling. Labor supply during college, government grants and loans, as well as private loans, complement parental resources as means of funding college education. We find that the current financial aid system in the U.S. improves welfare, and removing it would reduce GDP by 4-5 percentage points in the long-run. Further expansions of government- sponsored loan limits or grants would have no salient aggregate effects because of substantial crowding-out: every additional dollar of government grants crowds out 30 cents of parental transfers plus an equivalent amount through a reduction in student’s labor supply. However, a small group of high-ability children from poor families, especially girls, would greatly benefit from more generous federal aid.

This paper shows that despite being decried as being unaffordable, the US higher education system is pretty close to optimal: people pay for what they get, and borrowing constraints are largely taken care of by family, loans and grants. There remains an information issue, though, as you do not want talented people from poor backgrounds to fall through the cracks. That said, the paper assumes that tuition is constant across all policy experiments. That is likely not correct, as I believe that loans and grants have increased the ability to pay tuition (which is not necessarily bad). This is still a great paper, and adding that wrinkle to an incredibly rich model is likely too much. And the paper has already 104 pages…

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