Enhancing growth and welfare through debt-financed education

Using an overlapping generations (OLG) model, we show how relatively small open economies can enhance their growth through educational subsidies financed via public debt and reduce their fertility rate. We show that subsidising education through public debt leads to an A-Pareto improvement of all generations. Even if a country is a net borrower in the international capital market, we show that this subsidy policy can help, under certain conditions, to improve its net borrowing position. This has strong implications for the calculation of the 3% deficit to Gross Domestic Product ratio set by the European Union because the analysis implies that public expenditures for education should be subtracted from the government deficit before applying the deficit criterion.