Inequality and Markets: Some Implications of Occupational Diversity

This paper studies the nature of long-run income distribution in a competitive economy with borrowing constraints. Parents can invest in their children’s education and leave !nancial bequests to them. All !nancial bequests must be nonnegative. In other words, parents cannot borrow from their children’s future earnings. There is a continuum of occupations with continuously varying entry (education or setup) costs. Owing to this lack of indivisibility in investment opportunities, the steady-state income distribution is unique (in contrast to a large literature on occupational choice with indivisibilities). Different occupations are imperfect substitutes for one another in the production process (in contrast to theories of Glenn C. Loury 1981, and Gary S. Becker and Nigel Tomes 1979, 1986). Hence, occupational returns are endogenously determined by a combination of supply-side and demandside factors. We show that if the span of occupational investments is wide enough, the wealth distribution is nondegenerate and long-run inequality arises. In this case, the average return to education must rise with the level of educational investment— the return to human capital is endogenously nonconcave. This !nding (see Propositions 1 and 2), which contrasts with the usual presumption that the private return to human capital is decreasing, constitutes the central empirically testable proposition of this paper.