This paper examines the impacts of endogenous credit constraints on labor supply, the accumulation of human capital, and consumption across agents that are heterogeneous in age, ability, and initial wealth. In our model, contrary to the standard human capital literature, credit constraints arise endogenously from default incentives. Building on the recent literature on sovereign debt, and most closely, the debt constrained markets literature set forth by Kehoe and Levine, we derive credit constraints from the optimal decisions of economic agents at each point in their lifecycle. Human capital levels, age, and the productivity of investment all affect the maximum credit attainable by an individual, because they determine the likelihood that he will be willing (and able) to re-pay the loan subject to the consequences of default. The consequences of default are also likely to depend on the full income and, hence, human capital of individuals (e.g. wage garnishments). Since default probabilities and the consequences of default depend on individual characteristics relevant to human capital productivity and initial wealth, borrowing constraints will also depend on those same characteristics.In equilibrium, there is mutual feedback between credit constraints and the human capital decisions of agents, affecting the distribution and welfare implications of public policy. The policies we study (e.g. public schooling, progressive taxation, and education subsidies) will, consequently, alter the default incentives of agents and their ability to borrow-something missed by models with exogenously imposed constraints. We, therefore, compare the implications of these types of policies when borrowing constraints are endogenous with implications derived in standard models with exogenous borrowing constraints or perfect credit markets. We focus on the interaction between the incentives (for default) produced by government policies and their general equilibrium effects. We also explore the efficiency of the current US government loan program, comparing it with alternative penalty structures that might be enacted.Finally, we intend to compare the effects of endogenous credit constraints in human capital models with on-the-job training with their effects in learning-by-doing models of human capital formation.
