Education spread and economic development - a coordination game approach

TEven though education exhibits strong positive externalities, there exists abundant evidence that the positive correlation between the spread of higher education and aggregate productivity tends to gradually disappear as a larger number of students attend college. To rationalize this apparent contradiction, we model college attendance through a coordination (Stag Hunt) game, where a set of youngsters decide whether to enrol in college or immediately enter the labour market. The benefits of higher education are reaped by everyone only if all youngsters decide to engage in higher education. We argue that the reward to college education tends to decline as it becomes widespread on account of two factors. First, the wage premium of skilled labour falls due to an increased supply. Then, new colleges tend to be set up in less dense areas, so that the average distance between a youngster’s residence and the closest university rises. The decrease in the reward of tertiary education is multiplied by its impact on the result of a Stag Hunt game. If such a reward is high, there will likely be a switch from the “risk dominant” Nash equilibrium, where no youngster decides to engage in tertiary education, to the “payoff dominant” equilibrium with unanimous enrolment in college. By contrast when the net reward of higher education becomes relatively low the outcome of the Stag Hunt will be instead a coordination breakdown, which might even lead to a fall in the productivity of the agents involved. The latter result was found in laboratory studies by Straub (1995) and Schmidt et al. (2003) among others and we can explain it in theoretical terms if we allow for incomplete information in the Stag Hunt game.