Information Frictions in Education and Inequality

Why does the place where children grow up shape their opportunities in life? This paper explores the role of imperfect information and local information transmission as a novel explanation. First, I uncover a new empirical fact: when the college premium is low, a higher share of college graduates living in a school-district is associated with lower college enrollment of students graduating from that district. While this pattern is hard to reconcile through models with local spillovers in the production of human capital, I show that it is consistent with a model featuring imperfect information and local learning. The key elements are uncertainty about the skill premium and learning through signals of wages earned by nearby college graduates. In this environment, more exposure to highly educated neighbors brings more information about the skill premium. However, this only translates into more education if the observed wages generate the perception of a higher skill premium. Calibrating the model to match micro data from Detroit, I find that this novel mechanism explains more than half of the college enrollment gap between children of parents with a college degree and children from parents with a lower education level. Implementing a disclosure policy that corrects inaccurate perceptions about the skill premium closes this gap substantially.