Public Education Expenditures, Growth and Income Inequality

Abstract

Public education expenditures are usually seen as having at least two desirable effects. On the one hand, it can foster economic growth through human capital accumulation. It can also decrease income inequality by offering every student the same learning opportunities. This paper studies both aspects of public education expenditures in a model of occupational choice with an endogenous supply of teachers. First, we show that the impact of public education expenditures on economic growth depends on the quality of teachers. The quality of the educational sector, in turn, depends on the level of public education expenditures as well as on the shape of the human capital distribution in the economy. In particular, we show that economies whose human capital distribution exhibits fatter tails can attract teachers of higher quality for the same level of public education spending. This implies that empirical studies aiming at identifying the role of public education expenditures should control for higher-order (beyond the mean) of the human capital distribution. Second, this paper documents a U-shaped relationship between public education spending and income inequality for a cross-section of countries as well as across US states. In our model of occupational choice, managers and workers are imperfect substitutes in production. Increasing public education expenditures (through increased taxation) modifies occupational choice, supply and demand of workers. Whereas an increase in public education spending benefits all through an improvement of production efficiency, relative income gains at the top and bottom of the distribution depends on the reallocation of labor across occupations and changes in human capital distribution. The general equilibrium interaction between these different forces can result in a U-shaped relationship between the level of public education spending and income inequality. We calibrate our model on data from 8 OECD countries and show that some countries, among which the U.S., could spend more on public education to yield more income growth and less income inequality.