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Capital Market Failure, Adverse Selection and Equity Financing of Higher Education

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Author Info
Bas Jacobs () (European University Institute, and Universiteit van Amsterdam)
Sweder J.G. van Wijnbergen () (Universiteit van Amsterdam, and CEPR)
Abstract

We apply theories of capital market failure to ana1yze optima1 financing of risky higher education. In the market solution, students can only finance their education through debt. There is underinvestment in human capita1, because some students with socia1ly profitable investments in human capita1 will not invest in education due to adverse selection problems in debt markets and because insurance markets for human capita1 related risk are absent. Lega1 limitations on the use of human capita1 in financia1 contracts cause this underinvestment; without them private markets would optima1ly finance these risky investments through equity rather than debt and supply income insurance. The government, however, can circumvent this problem and implement equity and insurance contracts through the tax system using a graduate tax. This paper shows that public equity financing of education coupled to provision of some income insurance is the optimal way to finance education when private markets fail due to adverse selection. We show that education subsidies to restore market inefficiencies are sub-optimal.

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Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 05-037/3.

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Date of creation: 06 Apr 2005
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Handle: RePEc:dgr:uvatin:20050037

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Related research
Keywords: human capita1 capital market imperfections credit rationing financing risk investment optimal education finance graduate taxes education subsidies

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Find related papers by JEL classification:
H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
H52 - Public Economics - - National Government Expenditures and Related Policies - - - Government Expenditures and Education
H81 - Public Economics - - Miscellaneous Issues - - - Governmental Loans and Credits
J24 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Human Capital; Skills; Occupational Choice; Labor Productivity

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Robert A. J. Dur & Amihai Glazer, 2005. "Subsidizing Enjoyable Education," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
    Other versions:
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