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Human Capital Investment and Debt Constraints

Author

Listed:
  • David Andolfatto

    (Simon Fraser University)

  • Martin Gervais

    (University of Western Ontario)

Abstract

When young individuals face binding debt constraints, their human capital investments will be insufficiently financed by private creditors. If generations overlap, then a well-designed fiscal policy may be able to improve human capital investments by replacing missing capital markets with an intergenerational transfer scheme. Boldrin and Monte (2002) demonstrate that the optimal (balanced budget) fiscal policy in this context entails the joint provision of an education subsidy for the young and a pension program for the old, financed with a tax on those in their peak earning years. We demonstrate, however, that the desirability of such a policy depends crucially on the assumption of an exogenous debt constraint. If debt constraints arise endogenously for reasons of limited commitment, then the optimal (balanced budget) fiscal policy looks radically different. Furthermore, we find that arbitrary (non-optimal) policy interventions may actually lead to lower levels of human capital investment as altered default incentives induce private creditors to contract the supply of student loans by an amount greater than the subsidy. In some cases, the constrained-optimal policy entails zero intervention. These results highlight the importance of taking seriously the reasons for why debt constraints exist, before recommending any specific policy intervention.

Suggested Citation

  • David Andolfatto & Martin Gervais, 2004. "Human Capital Investment and Debt Constraints," Labor and Demography 0412006, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpla:0412006
    Note: Type of Document - pdf; pages: 18
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