College is often considered as an engine of intergenerational mobility of socioeconomic status. Yet whether children from disadvantaged backgrounds are able to move up the economic ladder through college largely depends on the college selection process, which has key implications for both inequality of outcomes and inequality of opportunities.

This paper studies the impacts of various college admission policies, specifically ability-based vs. tuition-based, on sources of lifetime inequality and intergenerational mobility where households compete against each other for limited college seats. To do so, we develop a heterogeneous-agent life-cycle model with endogenous human capital formation, where parents invest in child’s human capital for multiple periods. The college admission stage links three key dimensions of early childhood development—(1) child innate ability, (2) parental investment, and (3) family transfers for tuition—to adult labor market outcomes, as workers with college degrees enjoy higher returns to human capital and wage growth paths over their life cycle.

We start with the benchmark college selection scheme featuring competition for college admissions in terms of human capital, where the probability of getting into a college depends almost entirely on a child's human capital relative to that of other children in the same cohort. We estimate the benchmark model to China in the 2010s using the method of simulated moments. We then compare our benchmark economy with an alternative one under a tuition-based college admission scheme that requires a high tuition cost for attending college. The college decision then is determined endogenously by households.

Our main findings are threefold. First, we find that an ability-based scheme, where households compete for college admissions in terms of human capital, increases parental investment-to-income ratio from 0.06 to 0.13 and child human capital by 11.0% on average, but at the cost of 4% reduction in parental consumption. Second, in terms of sources of lifetime income inequality, differences in nature (child innate ability) and those in nurture (parenting and transfers) play approximately equally important roles, so do differences across people established early in life and those stemming from luck experienced throughout the working lifetime under benchmark economy. Switching to a tuition-based system while holding college capacity fixed yields a larger contribution of nurture relative to nature, as well as adult income risk relative to initial labor market conditions. Third, a tuition-based college admission system leads to a significant increase in intergenerational persistence of both education and lifetime income compared to the benchmark ability-based one.