Policies to Free a Trapped Economy: The Case of Sub-Saharan Africa

Abstract

In this paper, we argue that the condition of education and the economy of the low performing sub-Saharan African countries can be characterized as a stagnant steady state -- a trap. We present a simple heterogeneous-agent model in which high costs of education relative to income and the skill premium can cause the economy to be trapped in such a steady state with minimal educational attainment. We calibrate the model to available data from the sub-Saharan African countries to study policies that could potentially free these trapped economies and set them on a path to a higher steady state. We find that a tax and subsidy scheme that redistributes resources at the trap from poor households with lower ability children to those with higher ability children can pry the economy out of the trap, thus freeing it from dependence on foreign aid in order to achieve the same goal. In addition to the direct cost, a portion of the indirect cost also needs to be subsidized. Moreover, such a policy outperforms the abolition of child labor and the institution and enforcement of compulsory education laws when expenditure neutral welfare comparisons are made.

Keywords: Dynamic heterogeneous-agent models, Education subsidies, Economic stagnation

JEL Classification: O11, E60, I22