Government and human capital in a model of development through modernization and specialization

Economic development is associated with the shift of production from the traditional sector (e.g. traditional agriculture and the urban informal sector) to the modern sector (e.g. modern manufacturing and commercial agriculture). Human capital accumulation, particularly, education and job training of skilled workers, is a crucial factor in the modernization of an economy. Several institutions such as the protection of property rights and the strength of the rule of law also are considered essential. Thus, the government has an important role as the main provider of 'institution-maintaining' services, although it often faces a difficulty in providing adequate amounts of the services due to costly hiring of educated officers and tax avoidance. This paper analyzes interactions among taxation, the provision of the public services, human capital accumulation, and modernization, based on a dynamic dual economy model, which draws on the Becker and Murphy (1992) model of skill and task specialization, and examines conditions for successful development. Distributions of political power and wealth as well as sectoral productivities and the cost of education affect the outcome qualitatively. In particular, the socially desirable distribution of political power is such that educated (uneducated) individuals should have dominant power at an early (late) stage of development. Further, it is shown that several novel or overlooked inefficiencies arise naturally from realistic features of the model and appropriate redistribution can correct the inefficiencies except at a fairly early stage of development.