Optimal education policies under endogenous borrowing constraints

This paper studies optimal education policies under endogenous borrowing constraints in a standard life-cycle model. In a closed economy, a policy that appropriately bundles an education subsidy with an old-age pension can restore the complete market allocation. Such a policy also removes persistent indeterminacies and endogenous fluctuations that exist in its absence. In a small open economy, a similar policy may restore the complete market allocation for a wide range of parameters, a range much wider than previously believed. These results broaden the rationale for a two-armed welfare state (education and pension) to a large class of economies.