Inequality of Opportunity and Inequality of Effort: a Canonical Growth Model

Abstract

Theoretical and empirical studies exploring the effects of income inequality upon growth reach a disappointing inconclusive result. Some recent empirical papers have emphasized that one reason for this ambiguity could be that income inequality is actually a composite measure of inequality of opportunity (IO) and inequality of effort (IE). These types of inequality would affect growth through opposite channels, so the relationship between inequality and growth would depend on which component is larger. Based on this preliminary empirical result, we build an intergenerational model with human capital of inequality and development. The existence of a trap in the process of human capital accumulation generates multiplicity of equilibria and permits the inclusion of social mobility in the analysis. The model is able to explain how IO and IE affect human capital accumulation and hence ongoing long-run growth. The existence of social mobility in society makes the relationship between income inequality and growth to be non-linear, and the final sign of the in fluence of inequality on growth to be dependent on the degree of development and overall inequality of the economy. We find that IE is generally benefi cial to human capital accumulation and, therefore, to ongoing growth, while IO positively affects human capital (income) only for less developed economies.