Human Capital Accumulation, Economic Growth and Optimal Policy in a Dual Economy∗

This paper develops an endogenous growth model with dualism in human capital accumulation of two types of individuals. The government imposes a proportional redistributive tax on the resources of the rich individual to finance the educational subsidy given to the poor individuals. We find out the properties of optimal tax cum educational subsidy policy using Stackelberg differential game framework. The government plays the role of leader and the representative households are followers. The government chooses the tax rate to maximize the welfare of the economy subject to the decentralized competitive equilibrium conditions. Thus, the maximization problem by the government is also constrained by the private agents’ optimal decision rules. We also derive the properties of steady-state growth equilibrium and transitional dynamics of this model. JEL Classification: C61, J24, O15, O41