Liquidity Constraints and Human Capital: The Impact of Welfare Policy on Arab Families in Israel

Liquidity constraints might lead to children quitting school, even if the long run returns to schooling justify the investment. This study empirically tests for the existence of such liquidity constraints, by evaluating a policy decision that increased child allowances paid to Arab families in Israel during the 1990s. The identification strategy is based on the fact that the increase in the allowance to households with 4 or more children was much larger than the increase for households with 3 children. Using difference-in-differences methodology, I find that the increased allowance significantly raised high-school attendance of girls with low socioeconomic status, due partly to a decrease in their employment: An increase of 1% in family income as a result of school attendance. This evidence suggests that direct cash transfers to poor families in advanced economies can enhance the human capital accumulation of their children, even if the transfers are not conditioned on education.