Skill Dynamics, Inequality and Social Policies

Within a model where the parents make the decisions relating to their children’s education, we show that skill dynamics normally results in a sub-optimal situation involving income per capita. This derives from an under-education trap that is endogenously generated. When sub-optimality is caused by a lack of human capital at the steady state, a minimum wage or a redistribution policy makes it possible to increase output per capita and to reduce inequality because both increase the educated share of the population by raising certain households above the trap. These policies only need to be implemented over one period of time, i.e. one generation. Moreover, the sooner they are laid down, the more efficient these policies become. Finally, the income per head at the steady state is higher when individuals have naive expectations rather than when they have perfect predictions. Several simulations are performed that illustrate and corroborate these findings.