Education Financing and Student Lending

Abstract

As the cost of education rises and student debt reaches new highs, more research has focused on financing the acquisition of human capital. Most research has had a positive focus, examining the effect of debt on student choices and outcomes. However, because education financing involves many public policy choices, normative questions have become more prominent. We discuss the trade-offs involved in these choices and propose simple models to help shape these questions. We first develop an overlapping generations framework of student debt to examine the macroeconomic impact of shifting from a parent-funded to a student debt–based financing system. We then consider a framework that includes the supply-side response to different funding regimes; that is, how do enrollment and tuition decisions of schools respond to changes in education financing? We show that shifting from parent-based funding to a student loan program can lower aggregate savings, although welfare still improves if education has a higher return than physical capital investment. A public student loan program also tends to promote enrollment at the cost of higher tuition at for-profit schools and deteriorating loan performance, paid for by taxpayers. Alternative contract designs, with school participation in the lending program, tend to ameliorate these issues.