Collaborative Research: On Human Capital and Income Inequality

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In this research project we are interested in exploring the extent ex post inequalities between nations can arise when countries are ex ante identical. We study a model where imperfectly observable human capital investments are introduced in an otherwise standard neoclassical trade framework. Due to interaction between an informational externality and general equilibrium price effects, inequalities may arise in equilibrium when countries specialize in industries with different intensities in human capital. Citizens in the country specializing as a low human capital country are worse off than citizens in the country specializing as a high human capital country. Because incentives to invest are lower in the low human capital country the situation is self-enforcing. Incentives are bad in the poor country two reasons: 1) with few investors someone who "looks good" is more likely an individual with low human capital that got a "lucky draw"; 2) the possibility to import goods intensive in human capital from the other country makes human capital less valuable compared to a situation where countries don't trade. In our research we will explore how these effects interact and the extent the model provides a rationale for specialization as well as provide a number of testable implications of the model.