Human Capital Formation with Endogenous Credit Constraints

We study the accumulation of human capital and the behavior of consumption and earnings in a life cycle equilibrium model with endogenous borrowing constraints. Constraints arise endogenously from the inalienability of human capital and the limited punishments that creditors are able to impose on those who default. The endogeneity of borrowing constraints produces a number of interesting relationships. First, efficient borrowing limits are functions of individual observable characteristics and choices, especially ability and human capital investments. The connection between human capital investments and borrowing limits creates additional incentives to invest beyond those present in models with exogenous constraints. Second, government policies affect the incentives to default and, hence, the limits on private borrowing. As opposed to exogenous constraint models, additional subsidies for investment in human capital should be accompanied by increases in credit, since borrowers are more able to re-pay higher debts. Finally, general equilibrium considerations have an additional role, since borrowing limits depend on the returns to physical and human capital. We calibrate the model to U.S. data and are able to replicate key features of the economy regarding human capital investment, earnings, and consumption. The calibrated model is then used to study the steady state impacts of changes in government policies. We find that changes in bankruptcy laws can have sizeable effects on the accumulation of both human and physical capital. At the aggregate level, general equilibrium forces are important and can reverse the results predicted in partial equilibrium. Government subsidies to education (financed with a proportional tax on earnings) cause lenders to increase credit limits and substantially increase aggregate human and physical capital. Most importantly, we show that the implications of our model are very different from those of standard exogenous constraint models. For example, the effects of increases in initial wealth and government subsidies on investment are substantially greater in our model than in a similar model with exogenous constraints.

Foreign Know-How, Firm Control, and the Income of Developing Countries

Managerial know-how shapes the productivity of firms by defining the set of available technologies, production choices, and market opportunities. This know-how can be reallocated across countries as managers acquire control of factors of production abroad. In this paper, we construct a quantitative model of cross-country income differences to study the aggregate consequences of international mobility of managerial know-how. We use the model and aggregate data to infer the relative scarcity of this form of know-how for a sample of developing countries. We also conduct policy counterfactuals and find that on average, developing countries gain up to 23% in output and 9% in consumption when they eliminate all barriers to foreign control of domestic factors of production.

Credit Constraints in Education

We review studies of the impact of credit constraints on the accumulation of human capital. Evidence suggests that credit constraints are increasingly important for schooling and other aspects of households' behavior. We highlight the importance of early childhood investments, since their response largely determines the impact of credit constraints on the overall lifetime acquisition of human capital. We also review the intergenerational literature and examine the macroeconomic impacts of credit constraints on social mobility and the income distribution. A common limitation across all areas of the human capital literature is the imposition of ad hoc constraints on credit. We propose a more careful treatment of the structure of government student loan programs as well as the incentive problems underlying private credit. We show that endogenizing constraints on credit for human capital helps explain observed borrowing, schooling, and default patterns and offers new insights about the design of government policy.Human Capital, Incentive Problems, Government Loans, Early Investments, Social Mobility

Access to Credit and the Effect of Credit Constraints on Costa Rican Manufacturing Firms

This paper examines the finances and the effect of credit limitations on the behavior and performance of firms in Costa Rica. The study is based on a survey of manufacturing firms conducted by the authors during 2001. The paper characterizes the profile firms’ finances, examines the determinants of firms’ access to banking credit and tries to assess the effect of credit constraints on the behavior and performance of firms. The paper finds that while banks are the main source of credit for larger firms, non-banking credit (trade plus informal credit) remains the leading source of funds for smaller firms. Moreover, own funds and informal credit is a leading form of credit for newly created firms. It is also found that the probability of having banking credit and the fraction of banking credit/total debt is mostly affected by (if anything) characteristics of the firm and not by those of their owners. Indeed, the firm’s value and age, and whether it keeps formal accounting procedures appear as the most relevant determinants of access to banking credit. With respect to the starting up finances of firms, the data is not conclusive on the determinants of banking credit, yet it suggests a negative relationship with the previous entrepreneurship experience of the owner. The paper discusses different explanations, all of which highlight the importance of credit constraints. Adopting ideas from the econometric literature on treatment effects, the paper explores the effect of banking credit on the behavior and performance of firms. Two different methods are used to correct for selection biases: a parametric two-step point method and a non-parametric method that estimates upper and lower bounds for the effects. While the results are not statistically conclusive, both methods do suggest that having access to banking credit positively affects firms’ performance.

Enforcement, Contract Design, and Default: Exploring the Financial Markets of Costa Rica

This paper examines the institutional determinants of incentives to repay in Costa Rica and their effects on defaults and the design of financial contracts. Enforcement mechanisms help to determine how much is paid back to creditors and how much shareholders receive as dividends. Theoretically, however, the most important effects will be on the observable characteristics of contracts, as rational agents foresee the incentives of other parties. As courts enforce contracts and punish defaulters, they determine the form contracts take and the magnitude and direction of investments. The paper contains findings on the practices of financial intermediaries that are discussed in the context of contract theory, with a focus on the formal financial intermediaries that are scattered throughout the country. Much of the information comes from primary sources, including a sample of almost 1,700 civil trials and a detailed survey on the credit policies of 31 intermediaries. This paper reviews the creditor-borrower relationship at all stages—ex ante, interim, and ex post. The evidence supports the importance of collateral and other ex post repayment incentives. The evidence also suggests that, contrary to the common view, banks are not passive lenders. They remain alert to how well projects perform and rely on previous experience and a rather sophisticated informational network in granting credit.

Bailouts in Costa Rica as a Result of Government Centralization and Discretionary Transfers

This paper investigates the inter-relation between the central government and the municipalities in Costa Rica. It examines episodes in which the central government has bailed out the local governments from their obligations. We employ empirical and descriptive methods to show how discretionary grants relate to the degree of fiscal discipline of the municipality to produce hidden bailouts. Political, demographic, and economic variables explain the allocation of these discretionary transfers. We illustrate the effects of the high concentration of decision-making of the central government on the fiscal performance of the municipalities. The municipalities play a limited role and its functioning largely depends upon the central government. We argue that the national administration would face a high political cost if it did not bail out the local government in several of the episodes studied. Using panel data from 1982-1997 on 81 cantones, we find that the fiscal effort of the local government is reduced by the presence of discretionary grants. The local governments finance local expenses with these discretionary transfers according to our empirical results. As expected from the centralization issue, political variables such as the affiliation of the local administration have significant effects on the resources received by the municipalities.

Credit Constraints in Education

We review studies of the impact of credit constraints on the accumulation of human capital. Evidence suggests that credit constraints are increasingly important for schooling and other aspects of households' behavior. We highlight the importance of early childhood investments, since their response largely determines the impact of credit constraints on the overall lifetime acquisition of human capital. We also review the intergenerational literature and examine the macroeconomic impacts of credit constraints on social mobility and the income distribution. A common limitation across all areas of the human capital literature is the imposition of ad hoc constraints on credit. We propose a more careful treatment of the structure of government student loan programs as well as the incentive problems underlying private credit. We show that endogenizing constraints on credit for human capital helps explain observed borrowing, schooling, and default patterns and offers new insights about the design of government policy.