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Working Paper Summaries (WP/94/77 - WP/94/147)
Article

Summary of WP/94/100: “Tuition Subsidies in a Model of Economic Growth”

Author(s):
International Monetary Fund
Published Date:
February 1995
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For more than thirty years, economists have stressed the role of human capital development in long-run economic growth. In an effort to encourage human capital development and spur economic growth, many countries in Africa and throughout the world heavily subsidize the education of their citizens. These subsidies are often objected to on equity grounds, because their benefits may accrue predominantly to students from privileged backgrounds. However, this paper raises a second and possibly more fundamental objection; in countries with a limited pool of resources from which to finance investment in physical and human capital, subsidies to education can actually reduce the long-run fraction of the population that chooses to become educated. Thus, countries that reduce subsidies to education for fiscal adjustment reasons may actually realize long-run increases in the fractions of their populations that become educated.

The paper analyzes a general equilibrium, human-capital-based model of aggregative growth where a spillover exists between the sector producing human capital and the sector producing a composite consumption/capital good. The model also features educated unemployment, which arises because of a fixed wage for educated labor. Workers in the model must solve an asset allocation problem, choosing whether to invest in education, which is produced by a competitive education sector, or to invest their tuition money in physical capital. In equilibrium, the expected lifetime return on an investment in human capital equals the lifetime return on an investment in physical capital. The first part of the analysis characterizes the equilibrium for such an economy.

Because education firms are unable to capture their spillovers into the production of the composite good, the output of the education sector is lower in the decentralized equilibrium than would be chosen as the solution to the social planning problem. Accordingly, a government may choose to offer a tuition subsidy to encourage enrollment in education. The analysis of the model demonstrates, however, that such subsidies can have perverse effects, leading in some cases to long-run declines in the fraction of the population that chooses to become educated. This result is most likely to occur in countries, like many in Africa, where the education sector is relatively small and the rates of subsidy and of population growth are relatively high. A related implication is that the greater the rate of population growth and of educational subsidy, and the smaller the relative size of the education sector in a country, the less likely are cuts in educational subsidies--undertaken by the country’s government for fiscal adjustment reasons--to lead to substantial declines in the long-run educational attainment of its population.

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