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6300

5300

4300

3300

2300

1300

300

0

250

500

750

1000

1250

1500

1750

2000

24000

20000

16000

12000

8000

4000

0

0

250

500

Western Europe

Latin America

750

1000

1250

Western Offshoots

Africa

1500

1750

2000

Asia

Eastern Europe

Income Per Capita

28000

Western Offshoots

24000

GDP Per-Capita

20000

Western Europe

16000

12000

8000

Latin America

Eastern Europe

Asia

Africa

4000

0

1820

1870

1913

1950

1998

Year

Western

Offshoots

Western

Europe

Latin

America

Asia

Africa

Ratio:

Rich/Poor

400

450

400

450

425

1.1 : 1

1000

400

400

400

450

416

1.1 : 1

1820

1202

1,204

692

581

418

3: 1

2001

26,943

19,265

6,150

3861

1,489

18 : 1

(Based on Solow 1956)

Constant Technology

Discrete time: t 0, 1, 2, . . . ,

Two factors of production:

L t - Labor

K t - Capital

Produce one final good that can be used

for consumption or as capital in the

production process.

Factor supply

Labor supply at t 1 :

L t1 1 nL t

where:

L 0 is given

n 1

capital supply at t 1 :

K t1 S t 1 K t

where:

K 0 is given

S t - aggregate saving

0, 1.

A1:

n 0

Production

output produced at time t :

Y t FK t , L t

A2:

F k K t , L t , F L K t , L t 0,

F KK K t , L t , F LL K t , L t 0, for all K t , L t 0

lim k0 F k K t , L t

lim k F k K t , L t 0

F0, L t 0

FK t , L t FK t , L t

Y t FK t , L t L t FK t /L t , 1 L t fk t

where k t K t /L t

f0 0 L t f0 F0, L t 0

for all k t 0 :

f k t F K K t , L t 0

F K K t , L t dL t fK t /L t /dK t f k t

and

f k t L t F KK 0

F KK df K t /L t /dK t f k t /L t

lim k t 0 f k t lim k t f k t 0

Moreover:

since:

FK t , L t FK t , L t , differentiating with

respect to :

FK t , L t F K K t F L L t

and dividing by L t :

fk t f k t k t F L

fk t f k t k t F L 0

Remark:

In a competitive environment:

the rate of return per unit of capital (rental

rate):

F K f k t

the wage rate per unit of labor:

F L fk t f k t k t

Remark:

Since FK t , L t F K K t F L L t , it follows

from differentiating with respect to L t that

F L F KL K t F LL L t F L

F KL K t F LL L t 0

F KL 0

S t sY t

where s 0, 1

Capital Accumulation:

K t1 S t 1 K t

sL t fk t 1 K t

k t1

sL t fk t 1 K t L t

K

t1

L t1

Lt

L t1

k t1

sfk t 1 k t

k t

1n

k t 0 such that

k t1 k t t

where k 0 is given

y t Y t /L t fk t

k t 0 uniquely determines y t 0

Properties of k t :

0 0

sf

k t 1

k t

0 k t 0

1n

k

sf

t

0 k t 0

k t

1n

lim k t

k t 0

lim k t 1 0, 1

k t

1n

Remark:

The strict concavity of k t follows from:

1. the strict concavity of fk t

2. saving is a constant fraction of output

Steady states

k such that:

k k sfk 1 k

1n

n k sfk

there exist 2 steady states:

k 0 unstable

k 0 stable

Remark:

n sf k

Comparative Statics

Proposition.

dk 0

dn

dk 0

ds

dk 0

dk 0

Proof.

Let

Gk , n, s n k sfk 0

dk

dn

dk

ds

G

n

G

k

G

s

G

k

n sf k

fk

n sf k

exists a unique globally stable steady state

equilibrium

Comparative Dynamics

Let

k t k t1 k t

kt

Proposition.

d k t

0

dn

d k t

0

ds

d k t

0

dk t

Proof.

sfk t 1 k t

k t /k t

1n

sfk t n k t

1 nk t

sfk t

n

1n

1 nk t

kt

d k t

sfk t

1 0

dn

1 n 2

1 n 2 k t

d k t

fk t

0

ds

1 nk t

d k t

s

fk

f

k t k t 0

t

2

dk t

1 nk t

without technological progress

Testable Implications and Evidence

conditional convergence

convergence

convergence

35

36

Threshold Externalities

Y t A t FK t , L t A t L t fk t

where k t K t /L t

and A t Ak t

A H if k t k

Ak t

AL

if k t k

Dynamics:

H k t if k t k

k t1

L k t if k t k

Testable Implications

club convergence

Endogenous Growth

Ak Basic Model

(Based on Rebelo JPE 1991)

Production:

Y t AK t y t Ak t

where A n /s

The Dynamical System:

sfk t 1 k t

k t1

1n

sAk t 1 k t

1n

sA 1 k t k t

1n

therefore:

0 0

k t

sA 1

1n

1 k t 0

k t 0 k t 0

growth rate:

k t k t1 k t

kt

sfk t 1 k t

k t /k t

1n

sA n

1n

sA n

1n

1n

d k t

0

dn

d k t

0

ds

d k t

0

dk t

no conditional convergence

Growth Accounting

(Solow 1956)

CRS Production

Y AFK, L

Y A Y K Y L Y

A

K

L

j - the change in the variable between

two periods, j Y, A, K, L.

Y A Y K Y L Y

A

K

L

Y A K Y K L Y L

Y

K K Y

L L Y

A

A Y S K K S L L

K

L

Y

A

S K - the share of capital the elasticity of

output with respect to capital

S L - the share of labor the elasticity of

output with respect to labor

y Afk

y Y/L

k K/L

A y S K k

y

A

k

(Based on Diamond 1965)

Production

Y t FK t , L t

F satisfies A2

Y t FK t , L t L t Fk t , 1 L t fk t ,

where k t K t /L t

Wage per worker

w t fk t f k t k t

Return to capital ( 1 intrest rate between

t 1 and t

R t f k t 1

Individuals

A generation of size L is born every period

and lives for two periods

Individuals:

supply labor inelastically, consume and

save in their first life period

consume in the second

Utility of the working generation:

u t uc yt , c ot1

Budget constraint

c ot1 R t1 s yt R t1 w t c yt

c ot1

y

wt

ct

R t1

Optimization:

s yt sw t , R t1

since consumption (in second period) is

normal:

ds t 0

dw t

A3

ds t 0

dR t1

K t1 Ls yt

k t1 sw t , R t1

sfk t f k t k t , f k t1 1

under A3,

k t1 k t

Properties of k t :

k t 0

(follows from the normality of consumption)

0 0

k t fk t

Comment:

Aggregate saving per worker in

the economy

s t s yt s ot

where

s ot 1 k t

s yt k t1

s t s yt s ot k t1 1 k t

in the steady state:

s t s yt s ot k

Production

Y t FK t , L t AK t L t 1 L t Ak t

k t K t /L t

wage per worker

w t 1 Ak t

return to capital

R t Ak 1

1

t

utility

u t uc t , c t1 ln c t 1 ln c t1

1

optimization:

st 1 wt

2

1 1 Ak k t

k t1 s t

t

2

Properties of k t :

0 0

k t 0 k t 0

k t 0 k t 0

lim k t

k t 0

lim k t 0

k t

steady state

k

1 A

2

1/1

(Related to Uzawa IER 1965, Barro JPE

1990)

Production:

Y t FK t , H t

satisfies A2.

Ht Ltht

where L t L 1, and h t1 he t e t

note that this implies that human capital

fully depreciate at the end of each period

Y t y t h t fk t

where k t K t /H t K t /h t

Total investment in physical and human

capital is

S t sy t sh t fk t

depreciate at the end of each period

( 1)

Allocation of investment: a fraction of

savings is allocated to physical capital and

a fraction 1 to human capital.

k t1 sAk t h 1

t

h t1 1 sAk t h 1

t

y t1 Ak t1 h 1

t1

1

AsAk t h 1

t 1 sAk t h t

A 1 1 sAk t h 1

t

A 1 1 sy t

for sufficiently high: productivity of

education , saving rate s, and productivity

A there exists an efficient allocation such

that .

A 1 1 s 1

No convergence

No limit to human capital accumulation

(Based on Frankel AER 1962, Romer JPE

1986, Lucas JME 1988)

The level of technology is:

A t Ak t

is external to the firm

(in Lucas 1988 Ah is a function of human

capital)

Production:

y t Ak t fk t

where fk t is derived from a function

FK t , L t that satisfies A2

Suppose Ak t fk t is linear in k t

example:

Ak t k 1

t

fk t Bk t

y t Ak t fk t Bk t

Ak model with constant factor shares.

Endogenous R&D

Quality Ladder Model

(Related to Lucas JME 1988, Grossman

Helpman 1991; Aghion Howitt

Econometrica 1992)

The final good produced by each worker in

the final good sector is

yt At

where,

A t A t1 i t

A t1 is the non-excludable existing

technology and i t is new knowledge

(inventions) purchased by the worker.

Individuals

In each period a population of size N joins

the economy

Individuals are active one period in which

they work in the final good sector or in the

R&D sector

The number of workers in the R&D sector

is H t

The number of workers in the final good

sector (production) is L t

Lt Ht N

Production of technology:

The number of non-rival inventions each

worker in the R&D sector produces in t is:

A t1

inventions are made at the beginning of

the period and sold to producers

Equilibrium

In equilibrium all workers purchase all

inventions:

i t A t1 H t

A t A t1 A t1 H t A t1 1 H t

The surplus generated by each invention

used by each worker is 1.

workers and R&D workers: a fraction

0, 1 is allocated to the R&D worker

and 1 to the production worker.

income of each R&D worker in t is

I Ht A t1 L t

income of each production worker in t is

I Lt A t1 1 A t1 H t

(individuals are indifferent between the two

occupations) implies:

I Ht I Lt

A t1 L t A t1 1 A t1 H t

L t 1 1 H t

1 1 H t

Lt

1 H t H t

N Ht

1 H t

N

if N 1, for all t:

H N 1/

L 1 N 1/

if N 1

H0

LN

Since A t A t1 A t1 H

g t g A t A t1 H

A t1

N 1 if N 1

if N 1

Conclusions

1. Growth is affected by:

scale

R&D productivity

patents property rights

2. Crucial elements:

technology is non-rival and excludable

linearity of technological progress with

respect to the technological level

Comments

1. monopolistic competition

may generate over investment in R&D

2. externality to technology

may generate under investment in R&D

3. if investment in technology takes place

before benefits from the technology are

exhausted

the interest rate/time preference have an

effect on R&D investment

Criticism

(Jones 1995)

1. Economies of scale

2. Non decreasing productivity in R&D

inconsistent with empirical evidence from

the 20th century

3. New technology is proportional to the

stock of old technology

Define t

t A t A t1 A t

At

At

Suppose

A t1 A t A t

A t gR&DA t

1 gR&DA t

where R&D is constant over time

(it can be replaced by your favorite

candidate:

human capital, population, or anything

else)

t gR&D

and

A t gR&DA t

Suppose, in contrast

A t gR&DA t 1

1

t A t gR&DA t

1

At

if 1, t is growing over time

converging to infinity

if 1, t is declining over time

converging to zero

Economy

(based on Kremer 1993)

Production

A

X

t

Y t A t X L 1

Lt

t

Lt

where L t is the adult population in t, X is

the constant land size, augmented by a

productivity coefficient, A t .

income per adult individual is

A

X

t

y t Y t /L t

Lt

Individuals

live two periods: childhood and adulthood.

adults work, consume and raise children

Preferences:

u t 1 log c t log n t 0, 1

c t - consumption in the household

n t - number of children

Budget constraint

A

tX

c t n t

Lt

is the cost of raising a child

Optimization

nt AtX

Lt

where /

L t1 n t L t y t L t

Y t

A t X L 1

t

for any given A there exists a unique

globally stable steady state ,

L 1/ AX

the economy is at the proximity of the

Malthusian equilibrium:

L t 1/ XA t

Consider population dynamics under:

A t1 A t g

At

L t1 1 gL t

where L 0 is given.

L t 1 g t L 0

lnL t lnL 0 t ln1 g

Prediction: log population evolves

linearly over time.

with population size

A t1 A t gL ; g L 0

t

t

At

Prediction: log population is a convex

function of time.

century)

Consistent with #2

Interpretation:

A larger population generates more

non-excludable inventions.

A growing population allows for increasing

scope for division of labor.

The credit market imperfection

approach

(Galor and Zeira 1993)

Individuals

OLG

A generation of size 1 is born every period

and lives for two periods

Each individual has one parent and one

child

Individuals are endowed with a parental

bequest, invest in human and/or physical

capital,

in their second life period:

Individuals supply labor inelastically,

consume and bequeath

defined by the utility function:

u it 1 log c it1 log b it1

where 0, 1.

Budget constraint

c t1 b it1 I it1

there is an indivisible cost, h, invested in t

(in the first period of life) to become skilled

in t 1

unrestricted international capital flows at

the world gross interest rate R.

the gross interest rate for borrowers for

investment in human capital is

R

where 1.

Wages

w st w s

as follows from the production function

w ut w u

A1:

w s w u hR

A2: is sufficiently large such that:

w s w u hR

if b it h

I it1 w s b it hR

if b it h

I it1 maxw s h b it R, w u b it R

exists

b w u w s hR 0, h

R 1

such that

w s h b R w u b R

and individuals choose to invest in human

capital if and only if b it b .

education, which is strictly decreasing in b it

for b it h, is equal to the return,

h b R b R

hR b 1R

ws wu

b it1

for b it b

w s h b it R for b it b , h

w u b it R

w s b it hR

b it

for b it h

sufficiently large such that

R 1

w s h

A4: w u is sufficiently small such that

w u b 1/ R

implying that

w u b R b

Note that:

(1) this assumption can be expressed as

an assumption on the parameters:

w u 1 RhR w s /R 1

(2) A4 implies that

R 1

dynamical system is characterized by 2

stable steady states:

u

w

bL

1 R

i.e., b L b L R w u

s hR

w

bH

1 R

i.e., b H b H hR w s

and a threshold unstable steady state

s hR

w

bT

1 R

i.e., b T b T hR w s

the technology

(Moav 2002)

Production

Y t FK t , H t

H t - efficiency units of human capital.

Individuals

as in the Galor-Zeira model, with the

following utility function:

u it 1 log c it1 log b it1 ,

where 0, 1 and 0.

budget constraint:

I it1 b it1 c it1

b it1 bI it1

if

I it1 ;

I it1 if

I it1 ;

where 1 /.

Capital markets

unrestricted international capital flows at

the world capital rate of return, R, uniquely

determine the wage per efficiency unit of

human capital w.

(alternatively: Y t wH t RK t

individuals can not borrow for sake of

investment in human capital.

the level of human capital is an increasing

concave function of real resources

invested in education

1 e it if e it e;

h it1 he it

1 e

Assumption:

w R

if e it e.

I it1

w1 b it

if

b it e;

w1 e Rb it e

if

b it e.

since

if

I it1 ;

if

I it1 ;

if

I it 0;

w1 I it

if

I it 0, e;

if

I it e,

b it1

0

I it1

I it1

w1 e

RI it e

I it

Assumptions:

1.

w

2.

w1 e e

e

3.

R 1

w

w 1

1w

w 1

the dynamical system, I it1 I it ,

generates multiple steady states. A

poverty trap, I L w, a high income steady

state, I H , and a threshold income

I L , I H , where,

we 1 R e

H

I

.

1 R

wages

(based on Banerjee and Newman 1993)

Basic Galor Zeira model with random

shock to income and endogenous wages

Random shocks

a fraction 1 of individuals who did not

invest in human capital become skilled

workers

a fraction 2 of individuals who did invest in

human capital are unskilled workers

simplicity, are ignored by individuals when

making investment decisions.

Assumption A3 assures that the positive

shock places individuals in the basin of

attraction of the high income steady state

and it is assumed that the negative shock

places individuals in the basin of attraction

of the low income steady state. (this

assumption holds for sufficient low values

of , R and w u .

H t1 H t 1 2 1 1 H t

1 1 1 2 H t .

the steady state value of H,

H 1

1

distribution

Endogenous wages

output in the agricultural sector, Y At ,

Y At F A T, L t

where, T is the constant land size, F A is a

CRS production function characterized by

decreasing positive marginal products and

boundary conditions that assure an interior

solution to the producers maximization

problem.

w u w u L t

dw u L t /dL t 0, and lim L t 0 w u L t

it is assumed that

w u 1

where is the threshold level of w u above

which the dynamical system describing the

evolution of b it is characterized by one

steady state

there exists L such that w u L .

trap

for w u , is charctarized by a unique

steady state

Assume that

2

L

L

1 2

where L Therefore:

If L 0 L the economy will converge to the

steady state:

L L , H 1

1

dynamical system governing the evolution

of b it is characterized by a unique high

income steady state. In equilibrium

therefore a sufficient fraction of the

population will have a bequest b h and

the net return to education declines to

zero, uniquely determining the number of

uneducated workers in the steady state, L :

w s w u L hR.

b it1 w u L b t R w s b t hR

which is linear in equilibrium and has a

unique high income globally stable steady

state. In the steady state all individuals

converge to the high income steady state,

but they are subject to negative income

shocks that place them in a lower point

along the dynamical path. In the steady

state H 1 L .

Income mobility

(based on Maoz-Moav, 1999)

Production and wages

Y t FL t , E t

E t - the number of skilled (educated)

workers

L t - the number of unskilled workers

Et Lt 1

w et w e E t and w ut w u E t

Individuals

OLG

A generation of size 1 is born every period

and lives for two periods

Each individual has one parent and one

child

First life period:

receive b t from parent, consume and

invest in human capital

Second life period:

supply labor inelastically, consume and

bequeath

Preferences

u it log c it 1 log c it1 log b it1

c it - consumption when young

c it1 - consumption when old

b it1 - transfer to the child

to become skilled in t 1

Capital markets

do not exist

Optimization

The budget constraints of individual i are:

c it i h it b it

c it1 b it1 w it1

where,

i

1 i acquires education

0

otherwise

w it1

w et1

i 1;

w ut1 i 0.

zw it1 max1 log c it1 log b it1

s. t. c it1 b it1 w it1

b it1 w it1

individual i will choose to invest in human

capital if and only if:

logb it h it zw et1 log b it zw ut1

b it h it w et1 b it w ut1

b it

w et1 w ut1

w et1

i

h t h it

i

h t - the critical value of the cost of

i

i

education such that i will invest iff: h t h t

i i

i

i

e

h t /b t 0, h t /w t1 0, h t /w ut1 0.

e

w ut1

e

h t w t 1 e

w t1

u

w ut1

u

h t w t 1 e

w t1

independent of parental education and

time.

e

u

E t1 E t F h t 1 E t F h t

Since the left hand side is strictly

increasing in E t1 and the right hand side is

strictly decreasing in E t1

E t1 is uniquely determined by E t :

E t1 E t

where E t is increasing in , and w e ,

whereas w u has an ambiguous effect.

Across Regions, 1960-1999

7

1

1960

1964

Western Offshoots

1968

1972

Europe

1976

1980

Africa

1984

Asia

1988

1992

1996

Latin America

Oceiania

Europe: Total Fertility Rates

6

T o ta l F e r tility R a te

1

1851-1855

France

1876-1880

1901-1905

1926-1930

Netherlands

Germany

1951-1955

Norway

1976-1980

Sweden

Finland

view, across countries, and across individuals. An early discussion of this fact

appears in the seminal article on fertility choice by Becker (1960). Indeed this

puzzling correlation was one of the main impetuses to Beckers early work.10

Quoting from Becker (1960) (p. 217): Indeed, most data tend to show a negative

relationship between income and fertility. This is true of the Census data for 1910,

1940 and 1950, where income is represented by fathers occupation, mothers

education or monthly rental; the data from the Indianapolis survey, the data for

nineteenth century Providence families, and several other studies as well.11

Figure

1: Fertility

Incomeinin

2000

Dollars

Figure

3: CEBby

vs.Occupational

Occupational Income

2000

Dollars

6.5

Birth Cohort

6.0

1828

1848

1868

1888

1908

1928

1948

5.5

5.0

4.5

4.0

1838

1858

1878

1898

1918

1938

1958

3.5

3.0

2.5

2.0

1.5

0

20,000

40,000

60,000

80,000

In a recent study, Jones and Tertilt (2008) use U. S. Census Data on lifetime

fertility and occupations to document this negative cross-sectional relationship

in the United States.12 They find a robust negative cross-sectional relationship be10

The studies Becker is referring to are U.S. Census (1945), U.S. Census (1955), Whelpton and

Kiser (1951), and Jaffe (1940).

12

Income is based on the median annual income for a given occupation in 1950 and adjusted for

11

Endogenous fertility

(Moav, 2005)

Production

Y t wH t

where H t is the aggregate level of human

capital in t.

Individuals

live two periods:

In childhood they acquire human capital

in adulthood they work consume and raise

children

preferences:

u it 1 log c it log n it h it1

c it - consumption of the household

n it - the number of children

h it1 - the level of human capital of each

child, measured in efficiency units

h it1 he it ,

e it , is measured in efficiency units of labor

the real cost of the investment in

education is we it

educating each of his children. Therefore the effective

level of education is e it it h it , and the cost is

therefore it h it w, hence the cost of e it is we it

h0 1, h 0 , h e it 0, h e it 0.

Budget constraint

n it wh it e it c it wh it whe it1

is the minimum time cost required for

raising a child

A1:

1/

Optimization

Consumption:

c it 1 wh it 1 whe it1

Education:

if:

h0

1 h 0

h it

h it

e it 0

otherwise e it 0, is given by

he it

he it

e i

h

t

i

i

i

i

h t e t

he t1 e t

noting that

he it

d

h it e it

/de it 0

he it

e i

h

t

h it e it

h(et )

h(et 1 ) + et

1

h(et 1 )

h' (et )

(et 1 )

et

such that,

0 if e it

e it1 e it

0 if e it

where e it 0 for e it and 0 is

unique and given by 1/ h.

et +1

450

(et )

e eT

et

generates multiple steady states.

Consider for instance the following human

capital production function,

1 e it if e it ;

h it1 he it

1

where 1 / 2 .

if e it .

Hence,

if

e it ;

0, if

e it ;

e it ,

0

e it1 e it

if

. The dynamical system e it is

characterized by two stable steady states,

e and 0, and an unstable steady state ,

which is the threshold level of education.

n /

for e 0

n 1 /1 for e

where

/ 1 /1

System

An Example

y t Ak t h t ;

0, 0, 1

k t1 sy t

h t1 h t y t

where:

0,

s 0,

s 1 1

k t1 sAk t h t k t , h t

h t1 h t Ak t h t

Ak t h t

k t , h t

where

k k t , h t 0,

h k t , h t 0

kk k t , h t 0,

hh k t , h t 0

The kk Locus

Let kk be the locus of all pairs k t , h t such

that k t is in a steady-state:

kk k t , h t : k t1 k t :

k sAk h t

/1

k sA 1/1 h t

k h t

if k t k h t , then k t1 k t , h t k t

The kk Locus consists of all the pairs

k h t , h t

1 /1 1

k h t is increasing and concave

The hh Locus

Let hh be the locus of all pairs k t , h t such

that h t is in a steady-state:

hh k t , h t : h t1 h t :

h Ak t h

h

1/1 /1

kt

A

h k t

h t h k t , then h t1 k t , h t h t

The hh Locus consists of all the pairs

h k t , k t

If 1 /1 1

h k t is increasing and concave

dynamical system, the non-trivial steady

state levels of k h t and h k t are unique

and globally stable.

Alesina-Rodrik 1994, Persson-Tabellini

1994, Benabou 2000

(the model is based on Benabou 2000)

Wealth distribution

Cumulative distribution of (pre-tax) wealth:

Fx

for

x0

/1 x

for

x 0, 1 /

for

x 1 /

where 0, 1

The density function:

0

fx

1

x

for

x0

for

x 0, 1 /

for

x 1 /

1.2

0.8

a=0.3

a=0.7

a=0.9

0.6

0.4

0.2

0

0

0.5

1.5

2.5

3.5

1.8

1.6

1.4

1.2

1

a=0.3

a=0.7

a=0.9

0.8

0.6

0.4

0.2

0

0

-0.2

0.5

1.5

2.5

3.5

Mean income:

x

1/

1/

xfxdx

x 1

x dx

1/

0

Median income, m

Fm 1/2

Hence,

Fm

m 1

2

and therefore

m.

m 1 1/

2

Properties of m :

lim m 0

dm

d

m1

1 log 2

2 1/ 3

if

0 if

if

0

0, 1

1

0

0

Indices of equality:

1. Median/Mean ratio:

median m m

mean

x

the higher is the median, that is the

higher is , the lower is inequality.

2. Income variance:

2

varx Ex

x 2

1/

1/

x 2 fxdx 1

x 1 dx

1/

1

2

x

1

2

0

1

2

the variance of x is decreasing in , that

is the higher is , the lower is inequality

Note that for 1, varx 1/3, equal to

the variance of a uniform distribution with a

range of 2 (the variance of the uniform

distribution is given by r 2 /12, where r is the

range), and for 0 varx

Equality increases with

is a measure of equality.

Redistribution

Post-tax Income of individual i, x i :

x i 1 x i x

- fraction of wealth taxed and

redistributed equally among individuals

1 - distortionary taxation

1 - beneficial taxation

Redistribution is preferred by i if

x i x i x x i

for 1

x i x i x x i

if

x i x i x i

redistribution is supported by a fraction

F of the population:

F

for

/1

for

0, 1 /

for

1 /

For 0, 1

F

if 0

F/ 0 if 0, 1

F

/2

if 1

Note that:

For 0 :

lim 0 m 0 and thus F 1 since

0.

For 1 :

m x and thus F 1/2 since 1.

Hence for distortionary taxations:

More equality reduces the pressure for

redistribution.

For 1, 2

F 1/2

F/ 0 for

F/ 0 for

F2 1

for

low

high

expln 4 1/2, 2

1

1

0.9

=2

0.8

0.7

=1.5

0.6

0.5

=1

0.4

0.3

=1/2

0.2

0.1

0

0

0.2

0.4

0.6

0.8

captures two effects:

1. More inequality increases the

proportion of less than average income

individuals who support redistribution.

2. More inequality increases the cost of

redistribution for high income

individuals who object redistribution

Inequality and Growth

The theory predicts that inequality:

1. Has a negative effect on growth if

taxation is distorting 1.

2. Has a negative effect on growth if

1. 213, and inequality is sufficiently

low (high .

Geography, Transparency and Institutions

(Mayshar-Moav-Neeman)

two standard elements in the (implicit)

principal-agent contract:

Stick threat of dismissal

Carrot share of output

Institutions (private vs. state owned land)

State capacity

State concentration (center vs. periphery)

The principal designs the contract to

maximize its expected income

Agents are risk neutral and choose their

effort level to maximize their expected

welfare

The economy operates during two periods:

1 and 2

Y

H if e h and G

L

otherwise

e h, l - effort

G, B - state of nature

p 0, 1 - the probability that G

Information

, B - a public signal about the state

G

of nature

Signal accuracy q 1/2

|G PrB |B

q PrG

|B PrB |G

1 q PrG

is observed after effort decision

a. Observation of output in other plots

provides information about the state of

nature at a specific plot depending on the

correlation across plots.

b. An observable signal, such as the

Nilometer that measures the amount of

water in the Nile.

0 if effort is low e l

if effort is high e h

Assumptions:

L

(low output is larger than the maintenance

cost)

pH L

(effort is efficient)

I - agents expected income

U I - agents periodic utility when

exerting effort

1 - the agents discount factor

V - the value of the agents employment in

the second period

zero - agents value of unemployment

The principal pays the agent:

a bonus b 0 if output is high Y H

a basic wage regardless of output

The contract could include dismissal of the

agent at the end of period 1 if:

Y L and G

(otherwise the agent is retained)

x - the cost of replacing the agent

1 p p2

p

x

1p

1p

dismissing the agent when B is dominated by

never dismissing

period 1

Pure Carrot

(denoted by subscript c)

Stick and Carrot

(denoted by subscript s)

In period 2, only Pure Carrot is relevant

pb c

Minimizing the cost of incentivizing the

agent

b c /p

V pb c

The cost of employment for the principal

under Pure Carrot

c pb c 2

pb s p 1 pqV

p1 q 1 pqV

noting that V

bs

1 pq

p

under Stick and Carrot

s pb s 1 p1 qx

2 pq 1 p1 qx

s c for q q

q

1 px

1 px p

For q q Stick and Carrot

x

p

1p

q 1/2

incentivize the agent has to incur the cost

of dismissal x with probability

1 p1 q

The expected cost of using the stick

1 p1 qx

is decreasing with the quality of

information q

The expected income of the agent

I c pb c 2

The expected income of the principal

c pH L L 2

Efficient outcome

I c c pH L L

The expected income of the Agent

I s pb s 2 pq 2 pq

is decreasing with q

above q

Holding constant the bonus, b, a higher q

implies a lower probability of dismissal,

increasing the value of employment.

Therefore, as q increases b has to decline

to hold the incentive constraint binding.

The expected income of the principal

s pH L L 2 pq

1 p1 qx

is increasing with q

Lower payment to the agent and lower

probability of paying x

inefficient outcome

I s s pH L L 1 p1 qx

inefficiency declines with q

An Illustrative Calibration

EY pH 1 pL 1 (representing

about 1.5 tons of net grain)

p 0. 75, (a bad harvest occurs about

every 4 years)

x 1, 0. 2

q 0. 625

TotalincomeandAgent'sincome

1

0.9

0.8

0.7

0.6

0.5

0.4

0.3

0.2

0.1

0

0.5

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