The Macroeconomic Cost of College Dropouts

More than 40% of US college students drop out without gaining a degree. This paper investigates whether dropouts are largely due to academic ability or financial constraints. I provide empirical evidence that the probability of dropout is strongly associated with both ability and finances–even after controlling for other factors. I build a quantitative general equilibrium overlapping generations model, where individuals face incomplete information on their academic ability and uncertainty about the generosity of financial aid. The model simulations show that uncertainty regarding ability is responsible for 20% of the observed dropout rates, while uncertainty regarding financial aid explains up to 53%. Pursuing a policy that eliminates uncertainty about the college aid would increase the social welfare by as much as 2.3%, benefiting both college graduates and non-college graduates. Such a policy is largely self-financing due to endogenous improvements in skill allocation and associated growth in GDP.