A Theory of Inefficient College Entry and Excessive Student Debt

Abstract

When workers are myopic and the amount of financing provided by the government is sufficiently large, some workers acquire education even if they are better off without it. We show that government-provided loans generate a propagation mechanism that exacerbates inefficient college entry. Further, the extent of this inefficiency depends on the speed at which loans are provided, and not just on their amount. The extent of inefficient college entry also depends on the distribution of myopic workers in the population, and inefficiencies can arise even if not all workers are myopic. We extend the model to study the impact of the dropout rate and heterogeneous expectations as well the dynamic implications of inefficient college entry.