Education Financing Policy: Income Contingent Loans and Educational Poverty Traps

Abstract

This paper examines the role of income contingent loan policies in ensuring intergenrational mobility and propelling poor households out of persistent educational poverty traps and concommitant child labour traps. In developing economies, credit market imperfection frequently interacts with other rigidities to create long run ‘traps’ such that poor households stay poor generation after generation. In most of these cases, mass poverty, low average level of education and child labour go hand in hand. Yet the usual policy prescription of subsidized education is often not viable because of the associated large fiscal burden. In this paper, we analyse the dynamic consequences of pursuing an alternative policy - the income contingent loan policy - which is not only self-financing but may also be more effective than many other standard policies in creating dynamic incentives for acquiring education and thereby eliminating the long run ‘traps’. However, the efficacy of such a policy depends on the productivity of basic education system. Thus, effective elimination of long run poverty traps requires a holistic approach towards education, with emphasis on both primary and higher education.

Keywords: Poverty Traps, Education Financing, Income Contingent Loans

JEL Classification: I22, I25, I28, H52