Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/339384 
Year of Publication: 
2026
Series/Report no.: 
Helsinki GSE Discussion Papers No. 55
Publisher: 
Helsinki Graduate School of Economics, Helsinki
Abstract: 
This study characterizes optimal policy in an endogenous growth model where heterogeneous individuals choose between entering the workforce as unskilled labor or pursuing education to become skilled. In the decentralized economy, monopolists produce goods using both labor types. They purchase innovations from R&D firms, which employ skilled labor whose productivity increases with education duration. We identify two fundamental market distortions: the extensive margin (the decision to acquire skills) and the intensive margin (the duration of schooling). The social planner corrects these distortions through two primary instruments. A student grant is employed to internalize the positive externalities of education. Conversely, a targeted income tax on skilled labor corrects the intensive margin; by reducing the marginal benefit of prolonged schooling, the tax mitigates over-education and ensures a timely transition into the productive workforce. The government budget is balanced via a consumption tax, while government-backed loans relax liquidity constraints for heterogeneous students. The justification for these interventions vanishes when economic growth is absent or R&D productivity is independent of education duration. In these limiting cases, a laissez-faire approach is socially optimal, underscoring that education policy must be dynamically linked to the broader macroeconomic innovation environment.
Subjects: 
Endogenous growth
Human capital
R&D productivity
Optimal taxation
Student grants
Individual heterogeneity
Liquidity constraints
JEL: 
O41
I25
H21
J24
ISBN: 
978-952-7543-54-2
Document Type: 
Working Paper

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