Optimal Education and Pension Policy in a Growth Model

In OLG economies with physical and human capital, the growth path of the decentralized market equilibrium fails to achieve optimality, because individuals’ accumulation of physical and human capital is in general different from that which maximizes welfare along the Golden Rule path. In an OLG model with the education technology being homogeneous of degree one in education input and a parental human capital externality, Del Rey and Lopez-Garcia (2013) found that education taxes with pensions can attain the Golden Rule social optimum. However, the empirical evidence suggests a weak parental human capital externality. Our paper shows that it is optimal to subsidize, rather than to tax, education, when the parental human capital externality is smaller when the education technology is homogeneous with less than one degree.