Responsible researcher: Eduarda Miller Figueiredo
Original title: Education Policy and Intergenerational Transfers in Equilibrium
Authors: Brant Abbott, Giovanni Gallipoli, Costas Meghir and Giovanni L. Violante
Intervention Location: United States
Sample Size:
Sector: Education
Variable of Main Interest: Well-Being
Intervention Type: Student Loans
Methodology: GMM
Summary
This article studied the impact of financial aid policies on college performance, well-being, and the aggregate economy. The authors analyzed here constructed a heterogeneous agent life cycle with incomplete insurance and credit markets, presenting generational interconnections. The results suggest that financial returns are always positive and increase according to capacity. Through the lens of the model applied in this study, the authors suggest that the current configuration of federal loan and grant programs has substantial value in terms of outcomes and well-being.
Investment in human capital is a fundamental source of aggregate productivity growth and important for social mobility. However, imperfections in the insurance and credit markets can distort skills investment choices that lead to suboptimal educational outcomes. This is why governments promote the acquisition of education through a variety of interventions, among them financial aid for college students.
Cognitive and non-cognitive skills, transmitted between generations, determine the non-pecuniary cost of education for students and productivity upon entering the job market. Government grants and loans, private loans, job offers during college to supplement resources given by parents as a means of financing the financial cost of a college education. Despite the fact that transfers made by parents to their children depend on the political environment, such as the availability of financial aid, and are motivated by altruism and the paternalistic attitude of those who give preference to their children's education.
This article aimed to study the impact of financial aid policies on college performance, well-being, and the aggregate economy. At the heart of the analysis is the role of liquidity constraints and uninsurable income risk, policy-induced exclusion from private sources of finance, heterogeneity and selection.
Studies using data from the 1980s and 1990s found that family income played a small role in college decisions (Cameron and Heckman, 1998; Cameron and Taber, 2004). However, more recently, Belley and Lochner (2007) found that parental financial resources mattered significantly for college attendance in the 2000s.
The authors define the life cycle of individuals based on four phases:
In the 1st phase the decision-making unit is the individual, in the last two the decision-making unit is the couple.
Men and women, in the model, begin to make their choices at age 16. Their skills are drawn from a distribution that depends on their parents' education and skills. In addition, parents make financial transfers to their children, giving them the start in life.
Given these inherited endowments of financial resources and skills, young people make their educational choices sequential: less than high school, high school, or college. During college, students can finance their education through borrowing in the private markets, through government grants and loans, and also by working part-time.
In relation to financial markets, the authors point out that families with positive savings receive an equilibrium interest rate equal to . For other families, banks lend at a rate of
, where
is the cost of supervising the loan per unit of intermediated consumption. Therefore,
it is an important determinant of the proportion of families that have negative net worth, which is 6.8% of the sample.
Individuals face debt limits that vary over the life cycle: high school students, young workers, and retired families cannot take out loans. So, high school students cannot borrow money or work. College lasts for two periods and the job offer at college is flexible, but the amount of time available for work is reduced due to the time needed for learning.
All college students have access to unsubsidized loans up to amount b , which accrue interest at rate r during and after college. Students with financial need have the interest on subsidized loans forgiven during college. Federal grants are awarded by the government through a formula that makes them a function of the parents' wealth and the student's abilities – that is, based on need and merit.
This article analyzed here constructed a life cycle heterogeneous agent model with incomplete insurance and credit markets of the type popularized by Ríos-Rull (1995) and Hugget (1996), presenting generational inter-linkages in the tradition of Laitner (1992) and situated in a context of overlapping generations. Study data was drawn from multiple sources across the United States[1].
The model is estimated in steps:
In equilibrium, individuals maximize their expected utility over their lifetime by choosing their level of education, federal loans such as college students, consumption and savings, labor supply, and inter vivos transfers to their children.
When estimating salary processes, they realized that the higher the level of education, the more pronounced the salary increases. The ability gradient for wages increases with education, suggesting a complementarity between the two. There is also a greater increase in capacity returns for women than for men.
The authors' results also show that a mother's education and cognition are important for her child's cognitive abilities. The results for the psychic cost of education show that being a woman increases the cost of high school, but has no effect on the psychic costs at college. And that non-cognitive and cognitive skills reduce education costs. Therefore, although measurable cognitive and non-cognitive skills play an important role, there is a large part of the psychic costs of education that remains unexplained, particularly for college.
The authors noticed that in the data from this research, male children receive larger transfers than female children. While boys receive an average transfer of just over $33,000, girls receive around $29,000.
The results also suggest that financial returns are always positive and increasing by ability, ranging from 5% in the lowest ability group to 10% in the highest ability group. What is surprising, according to the authors, is that the total returns are negative for those in the lowest skill group once psychic costs are taken into account.
After analyzing all the results, the authors conclude that the current US student aid program, including grants and subsidized loans, has improved well-being. Where improved well-being means: (i) improvements in aggregate production due to a greater stock of human capital; (ii) reduction of inequality in initial conditions due to a redistribution of income. Part of the effectiveness of expanding student subsidy programs through scholarships lies in the fact that parents' ability and education interact positively in producing skills for the next generation.
Through the lens of the model applied in this study, the authors suggest that the current configuration of federal loan and grant programs has substantial value in terms of outcomes and well-being. That further expansions of grant programs would improve well-being and that the best way to expand aid to students is through ability-based grants.
References
Belley, P., and L. Lochner (2007): “The Changing Role of Family Income and Ability in Determining Educational Achievement,” Journal of Human Capital , 1, 37–89.
Cameron, S. V., and C. Taber (2004): “Estimation of Educational Borrowing Constraints Using Returns to Schooling,” Journal of Political Economy , 112(1), 132–182.
Cameron, SV, and JJ Heckman (1998): “Life Cycle Schooling and Dynamic Selection Bias: Models and Evidence for Five Cohorts of American Males,” Journal of Political Economy , 106(2), 262–311.
Huggett, M. (1996): “Wealth Distribution in Life-Cycle Economies,” Journal of Monetary Economics , 38(3), 469–494.
Laitner, J.P. (1992): “Random Earnings Differences, Lifetime Liquidity Constraints, and Altruistic Intergenerational Transfers,” Journal of Economic Theory , 58, 135–170.
Ríos-Rull, J.-V. (1995): “Models with Heterogeneous Agents,” in Frontiers of Business Cycle Research , ed. By T. F. Cooley, chap. 4. Princeton University Press, Princeton.
[1] Current Population Survey (CPS), the Panel Study of Income Dynamics (PSID), the National Longitudinal Survey of Youth (NLSY, 79 and 97), the National Center for Education Statistics (NCES), the Survey of Consumer Finances (SCF), and the National Accounts.
[2] Parameters that determine the psychic costs of education, some preference parameters and others listed in table 6.2 of Abbot et al. (2020).
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