THE ROLE OF FAMILY TIES FOR THE OPTIMAL DESIGN OF HUMAN CAPITAL CONTRACTS

This paper studies the problem of financing a child's primary education when the parent is faced with credit constraints, contracting with minors is not possible and the legal enforceability of contracts is limited – a profound problem in many developing countries. It presents a model in which the empathy of agents towards their kinship ("family ties") is endogenized and self-enforcement of contracts is guaranteed through the interlinkage of credit markets – first a market for education credits, then a market for personal credits such as microcredits. We analyze the impact of increased mobility and anonymity observed in developing societies on the optimal contract design and allow for imperfect information. The main results are as follows: a decrease in information flow (regarding traceability of the whereabouts as well as borrowers' credit history) causes the interest rate of the education credit to always decrease, while the effect on the interest rate of the microcredit is ambiguous. The latter falls if the parent's empathy towards its child is independent of the child's empathy. Furthermore, we find that family ties not only represent an insurance for the family members against financial distress but can also dampen the negative effect of limited enforcement on the lender's payoff.