Technological Change and Public Financing of Education

We study investment in education in an overlapping generation model with altruism where credit market imperfections ration borrowing and cause persistent underinvestment in human capital. We characterize the optimal government policy and the policy that would emerge under majority voting in response to a technological change that raises the returns to education. The optimal government policy consists in a transfer of resources from future to current generations to finance investment in education and an increase in consumption for the current old generation. The policy chosen under majority voting accomplishes a generational transfer only if a majority of individuals are credit constrained. We consider two policy instruments: a labor income tax and an education subsidy. Current voters prefer a reduction in the current income tax rate to an education subsidy, as the former can finance an increase in their consumption.