From Physical to Human Capital Accumulation: Inequality and the Process of Development

This paper develops a uni...ed theory for the dynamic implications of income inequality on the process of development. The proposed theory argues that the replacement of physical capital accumulation by human capital accumulation as a prime engine of economic growth has changed the qualitative impact of inequality on the process of development. In early stages of industrialization as physical capital accumulation is a prime source of economic growth, inequality enhances the process of development by channeling resources towards individuals whose marginal propensity to save is higher. In later stages of development, however, as the return to human capital increases due to capital-skill complementarity, human capital becomes the prime engine of growth and equality, in the presence of credit constraints, stimulates investment in human capital and promotes economic growth. As wages increase, however, credit constraints become less binding, di¤erences in the marginal propensity to save decline and the aggregate e¤ect of income distribution on the growth process becomes therefore less signi...cant.