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Trade, Income Inequality, and Government Policies: Redistribution of Income or Education Subsidies?

  • Eckhard Janeba

This paper explores the role of government policies in a situation where the wage gap between high-skilled and low-skilled workers is widening due to increasing foreign competition in the manufacturing of low-skilled intensive goods. A two-period, two-sector general equilibrium model of a small open economy is developed in which individuals choose whether to invest in skills or not. The government influences individual decision-making by redistribution of income or by subsidizing investment in skills. Both types of policies have complicated effects on income inequality and social welfare. The first policy discourages investment in skills while the latter, although successful in inducing more investment in skills, tends to be regressive by favoring those who acquire skills. Yet for a given income tax rate the Lorenz curves of the two different policies intersect. When the government maximizes social welfare education subsidies are useful only if there is a high degree of inequality aversion and financing the subsidy is not too distortive.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7485.

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Date of creation: Jan 2000
Date of revision:
Handle: RePEc:nbr:nberwo:7485
Note: ITI
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