Education, Moral Hazard, and Endogenous Growth


We build an overlapping generations model of endogenous growth driven by human capital formation. Young people differ in their innate abilities, but these differences are not known even by the individuals themselves when they are going through the process of education, so that there are no adverse selection problems. The probability of successful completion of schooling depends on both innate abilities and effort level. Moral hazard arises because effort is not observable. Successful students become skilled workers while unsuccessful ones become unskilled workers. A utilitarian government that cares about income distribution within each generation transfers income from the rich (skilled workers) to the poor (unskilled ones). This is anticipated by the young pupils and reduces incentive for hard work. This results in a lower rate of graduation, and has an adverse effect on the growth rate of human capital and output. Comparative statics results across balanced growth paths are derived. The parameters of interest are the students' rate of time preference, their degree of effort aversion and the relative price of the skill-intensive consumption good.

Revised version: January 1998

JEL Classification number: O15, O41

Ngo Van LONG
Department of Economics, McGill University
855 Sherbrooke Street West
Montreal, Quebec, Canada H3A 2T7

Research Institute for Economics and Business Administration
Kobe University
Rokkodai-cho, Nada-ku, Kobe
657-8501 Japan
Phone: (81) 78 803 7036
Fax: (81) 78 803 7059

We thank an anonymous referee for very helpful comments and suggestions. We have also benefited from the comments of participants at the workshop "Economic Growth in Open Economies", Chinese University of Hong Kong in December 1996, and at IEAS, Taiwan, in May 1997. Comments from Been-Lon Chen and Sheng-Cheng Hu were helpful. Shimomura acknowledges the financial support from the Ministry of Education Scientific Research Grant #7630014.