Risky Human Capital Investment, Income Distribution, and Macroeconomic Dynamics

Abstract

This paper demonstrates that the role of the personal income distribution for an economy's process of development fueled by human capital accumulation critically depends on the shape of the saving function. Empirical evidence for the U.S. strongly suggests that the marginal propensity to save is increasing in income for income levels above a threshold, a property which so far has not been allowed for in the literature on human capital, income distribution and macroeconomics. Doing so, the present analysis suggests that the impact of higher inequality on the aggregate human capital stock, and thus, on growth is positive under rather weak conditions. Results heavily rely on a positive impact of parents' income on children's human capital investments, which holds under standard assumptions on labor income risk and risk aversion in the model, and is largely supported by empirical evidence.