Risky higher education and subsidies

Tertiary education in the U.S. requires large investments that are risky, lumpy, and well-timed. Tertiary education is also heavily subsidized. Our model suggests that despite adverse selection arising from encouraging poorly prepared students to enroll, observed collegiate subsidies improve outcomes substantially relative to the fully decentralized case. This result occurs because increases in subsidy rates for college education generate reductions in college failure risk without altering mean returns. We find that this mechanism is robust, and that tertiary subsidy rates well in excess of those observed in the U.S. can be justified by failure risk alone.