This paper develops a human capital-based structural equation model to analyze the mediocre-quality, low productivity, and low-performance levels characterizing large subsets of universities in developing countries. Using a structural equation model, we have first specified one particular way in which overall university performance might be related to human capital, social capital, and physical capital, which are in turn related to various indicators, including teaching-quality and research-productivity levels. The structural equation-based picture of these levels is then dynamically extended to obtain their trajectories over time. We have collected data to estimate the parameters of the human capital-based structural equation model, which then serves as a basis for the system dynamics simulations of teaching quality, research productivity, and overall performance over time. We have developed an optimally-formulated subsidy/reinvestment policy that helps create a self-reproducing process of quality/productivity/performance improvements within the university system. The policy is shown to facilitate these improvements, helping universities escape the mediocre-quality, low-productivity, low performance traps that plague many universities in developing countries.