4
Income Distribution and Growth

A third strand of literature focuses on the relation between income distribution and growth. Needless to say, this is not a new topic in economics. What characterizes the new contributions is their close connection with the new theories of endogenous growth, and a focus on previously neglected links from income distribution to growth, rather than from growth to income distribution.

In particular, the recent literature has focused on three links.11 The first approach stresses the role of imperfect capital markets. With perfect capital markets, anybody could borrow for his education against his expected future earnings. However, various departures from perfect market conditions including imperfect information about individual abilities and imperfect enforcement of loans, severely restrict the option of borrowing for education. Thus, most people (particularly the less well off) must rely on their own resources to invest in education. Thus, the initial distribution of these resources determines how many agents can invest, and therefore what is the resulting rate of growth of the economy. Important contributions to this line of research are Galor and Zeira ( 1993), Banerjee and Newman ( 1991) and Aghion and Bolton ( 1996). For instance Galor and Zeira show that the effects of wealth distribution on growth depend on the level of wealth per capita. If a country is relatively poor, then wealth inequality may be growth enhancing, because in this case at least someone will have enough resources to acquire education, generating positive externalities that will benefit other agents later on. By contrast, if wealth is equally distributed no group might be above the necessary threshold to invest in education. As aggregate wealth grows, less inequality becomes more beneficial because even the middle class can start investing in education, provided wealth is not too concentrated in few hands.

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11
For an excellent recent survey see Benabou ( 1996).

-26-

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