In many countries higher education institutions have expanded significantly over the last 60 years. There is an ongoing debate related to the issues of quality and efficiency of these institutions resulting in questioning their public funding. Our goal is to examine the theoretical justification for the establishment of higher education institutions, called 'Colleges', in addition to the higher quality Universities. We study the role of Colleges, subsidized or unsubsidized by the government, and their contribution to the economic growth. Our framework is an economy in which heterogeneous young individuals, following the basic education stage, optionally invest in higher education to achieve skills. Initially, Universities enjoy excess-demand and provide publicly funded uniform student subsidies. Given the capacity constraints of the 'Universities', our analysis explores the impact of adding new institutions, to the higher education system, assuming that Colleges are less productive than Universities and their cost (per student) is lower. Young individuals, are born with heterogeneous
'initial endowment' (a factor of random innate ability and family background) and are screened for admission to the various higher education institutions. We study the role of higher education in generating human capital and growth and obtain that:
(1) Given that Colleges have lower cost per student and can be introduced faster than adding Universities (which are also research institutions), the government should enhance establishment of Colleges .
(2) The government should divert some of the higher education public resources to Colleges at the expense of Universities, under certain conditions.
Our analysis suggests that, whether the College students are subsidized by public funding or not, Colleges play a crucial role in generating future human capital. Therefore, based on economic growth considerations it is recommended to establish Colleges and even divert some of the higher education funding from University students to College students.
Considering the form of funding, we further show in this paper that each higher education institution (a University or a College) should allocate subsidies to its disadvantaged students (need-based subsidies). Moreover, the typical combination of merit-based subsidies (allocated to students with high initial endowments) and need-based subsidies is more desirable under some conditions.
