Risky human capital investment, income distribution, and macroeconomic dynamics

Abstract

This paper examines the implications of human capital risk for the relationship between inequality and economic development. It argues that due to missing insurance markets for human capital risk, the initial distribution of family wealth may play an important role for an economy’s process of development fueled by human capital accumulation. The analysis suggests that, in the absence of credit constraints, higher inequality tends to increase the aggregate human capital stock and per capita income, under conditions which are supported empirically for advanced countries. Taking additionally into account that, due to borrowing constraints, higher inequality impedes human capital investment in poorer economies, this suggests a non-linear relationship between inequality and economic development.