Bitter Roots that Prevent the Sweet Fruits of Education

Abstract: In nearly all developed countries, the fraction of elderly in the population will rise considerably during the next four decades. This rise in old-age dependency will have significant ramifications for welfare. Additional investments in education induced by factor price changes could counteract some of the negative welfare effects if markets are efficient. To evaluate this human capital adjustment mechanism, we develop an overlapping generations (OLG) model with endogenous labor supply and Ben-Porath human capital accumulation calibrated for the case of Sweden. In our model, education is not only financed by firms, but also by agents themselves. The government subsidizes tuition and pays out a pay-as-you-go financed pension benefit to the retired. We show that the existence of borrowing constraints can significantly hamper the welfare improving adjustments of investments in education in response to higher old-age dependency. Increasing tuition subsidies does not solve the problem of a binding constraint on credit. Rather than alleviating the borrowing constraint, higher subsidies make it more binding.