Financial Intermediation and Costly Technology Adoption under Uncertainty: A Political Economy Perspective
We develop a stochastic political economy model to explain the trade-off between growth and inequality during the process of technology adoption. In the model endogenous growth occurs through physical and human capital deepening. Agents can adopt either of the two risky high-return technologies, one of which is only available to those who can afford the entry cost associated with financial intermediation. We assume that this entry cost depends on the proportion of government revenue that is allocated towards cost-reducing financial development expenditure, and that agents decide on this proportion through a voting mechanism. The results show that certain interest groups comprising of both the poorest and the richest agents block the policies that are aimed at allocating resources towards costreducing financial development expenditure in the early stages of the economy’s development. However, as redistribution continues from generation to generation, the middle of the distribution successively becomes thicker and consequently the majority of agents start supporting reallocation in the form of cost-reducing financial development expenditure. In the transition to the steady state, inequality patterns show recurring ‘Kuznets-like curves’. Furthermore, high initial inequality tends to hasten the pace at which growth and inequality converge towards the steady state paths, while low inequality result in more fluctuations in transitional growth and inequality. Finally, our results show that although the political outcomes do not coincide with the welfare maximisation outcomes in the early and the transitional stages of the economy, the two outcomes eventually converge in the long-run.
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