Competition, human capital and income inequality with limited commitment

We develop a dynamic general equilibrium model with two-sided limited commitment to study how barriers to competition, such as restrictions to business start-up, a¤ect the incentive to accumulate human capital. We show that a lack of contract enforceability ampli…es the e¤ect of barriers to competition on human capital accumulation. High barriers reduce the incentive to accumulate human capital by lowering the outside value of ‘skilled workers’, while low barriers can result in over-accumulation of human capital. This over-accumulation can be socially optimal if there are positive knowledge spillovers. A calibration exercise shows that this mechanism can account for significant cross-country income inequality. We would like to thank the following for insightful comments: Michele Boldrin, Francesco Caselli, Hugo Hopenhayn, Boyan Jovanovic, Narayana Kocherlachota, Omar Licandro, Stephen Parente, Nancy Stokey and participants at several seminars and conferences. Previous versions of this paper have circulated under the title “Competition, Innovation and Growth with Limited Commitment”. Marimon acknowledges support from Ente Luigi Einaudi, Fundación BBVA and Ministerio de Educación y Ciencia (SEC200303474 and FEDER). Quadrini acknowledges support from the National Science Foundation.