Barany, Zsofia Luca
(2011)
Essays on the macroeconomics of inequality.
PhD thesis, London School of Economics and Political Science.
Abstract
This thesis contains three essays on the macroeconomics of inequality.
The first chapter analyses the effects of minimum wages on inequality. While there
has been intense debate in the empirical literature about the effects of minimum wages
on inequality in the US, its general equilibrium effects have been given little attention. In
order to quantify the full effects of a decreasing minimum wage on inequality, I build a
dynamic general equilibrium model, based on a two-sector growth model where the supply
of high-skilled workers and the direction of technical change are endogenous. I find that a
permanent reduction in the minimum wage leads to an expansion of low-skilled employment,
which increases the incentives to acquire skills, thus changing the composition and size
of high-skilled employment. These permanent changes in the supply of labour alter the
investment
ow into R&D, thereby decreasing the skill-bias of technology. The reduction
in the minimum wage has spill-over effects on the entire distribution, affecting upper-tail
inequality. Through a calibration exercise, I find that a 30 percent reduction in the real
value of the minimum wage, as in the early 1980s, accounts for 15 percent of the subsequent
rise in the skill premium, 18.5 percent of the increase in overall inequality, 45 percent of
the increase in inequality in the bottom half, and 7 percent of the rise in inequality at the
top half of the wage distribution.
In the second chapter, I construct a model, where the supply of skills and the skill
premium can increase jointly, as occurred in the US over the past few decades. I high-
light the importance of the joint determination of the direction of technical change and
skill formation. There is a positive feedback between these two variables. Technological
progress is driven by profit oriented R&D firms, where profits are increasing in the amount
of labour that is able to use these technologies. Therefore, when the supply of high-skilled
3labour increases, technology endogenously becomes more skill-biased. A more skill-biased
technology leads to a higher skill premium, which increases the incentives to acquire educa-
tion, and the supply of high-skilled labour rises. During the transition to the steady state,
both quantities increase simultaneously. I map the dependence of the transition path of
the economy on the initial skill supply and relative technology between the high- and the
low-skilled sector. I find that, contrary to the previous literature, the skill premium and
the skill supply can increase jointly even if the bias of technology is weak.
In the third chapter, I relate the degree of progressivity of the income tax scheme
to the prevailing income inequality in the society. I find that, consistent with the data,
more unequal societies implement more progressive income tax systems. I build a model of
political coalition formation, where different income groups have to agree on a tax scheme to
finance the public good. I show that, the greater income inequality is, i.e. the further away
the rich are from the rest of the population, the less able they are to credibly commit to
participating in a coalition. Therefore, as income inequality rises, the rich are increasingly
excluded from the design of the income tax scheme. Consequently, the rich bear a larger
fraction of the public good, and the tax system becomes more progressive.
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