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Understanding the Income Gradient in College Attendance in Mexico: The Role of Heterogeneity in Expected Returns to College

Jan 2008
Working Paper
07-040
By  Katja Kaufmann
This paper studies the determinants of college attendance in Mexico. I use subjective quantitative expectations of future earnings to analyze both the causes and the implications of the steep income gradient in higher-education enrollment. In particular, I examine whether data on individuals’ expected returns to college as well as on their perceived earnings risk can improve our understanding of heterogeneity in college attendance choices. I find that while expected returns and perceived risk from human capital investment are important determinants, lower returns or higher risk are not sufficient, alone, to explain the poor's low attendance rates. I also find that poor individuals require significantly higher expected returns to be induced to attend college, implying that they face significantly higher costs than individuals with wealthy parents. I then test predictions of a simple model of college attendance choice in the presence of credit constraints, using parental income and wealth as a proxy for the household's (unobserved) interest rate. I find that poor individuals with high expected returns are particularly responsive to changes in direct costs such as tuition, which is consistent with credit constraints playing an important role. To evaluate potential welfare implications of introducing a means-tested student loan program, I apply the Local Instrumental Variables approach of Heckman and Vytlacil (2005) to my model of college attendance choice. I find that a sizeable fraction of poor individuals would change their decision in response to a reduction in the interest rate, and that the individuals at the margin have higher expected returns than the individuals already attending college. This suggests that policies such as governmental student loan programs could lead to large welfare gains.