Abstract:
This thesis analyses three sets of issues: the relationship between income inequality and economic growth, the growth-maximizing degree of redistribution, and the quantitative significance of differences in total factor productivity in explaining differences in per capita income across countries. It examines these three issues within a unique dynamic general equilibrium model of economic growth and income distribution. In the model, growth may arise endogenously under specific conditions identified in this thesis. The notable features of the model environment include the absence of credit markets, heterogeneous agents with idiosyncratic shocks to the inborn talent of a child, complementarity between physical and human capital in the production technology of self-employed adults and fiscal and education policies involving progressive redistributions. In the above environment, the thesis examines three macroeconomic issues. Firstly, it examines the relationship between income inequality and economic growth from different perspectives and finds that the relationship between income inequality and growth could vary significantly between groups of countries with distinctive institutions and policy regimes. The model provides a way to reconcile the apparent disagreement on the empirical relationship between inequality and growth reported by other researchers. Secondly, it asks what degree of redistribution would be consistent with a growth maximising strategy for fiscal policy makers. To answer this question it introduces the notion of “threshold inequality” and identifies a condition involving that threshold to demonstrate when a redistributive policy facilitates output growth analytically. It then derives an explicit formula for the growth-maximizing degree of redistribution and applies the key theoretical result to the United States, New Zealand and Australia to characterise numerically the growth maximising degrees of redistribution for those countries. Finally, it presents a theory of total factor productivity and an explicit analytical expression to shed light on a recent empirical puzzle regarding cross-country income disparity. In particular, it helps to identify various sources of differences in total factor productivity across countries and provides explanations for empirical results about the quantitative importance of TFP in explaining differences of per capita income across countries. The key finding is that differences of TFP do not explain much of the differences of per capita income when the TFP differences arise due to differences in institutional parameters. However, the TFP differences explain a significant fraction of the differences of per capita income when they arise due to differences in the fiscal policy regimes. The model developed in this thesis can be used to examine other issues involving interactions between income distribution and economic growth in future studies.