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Essays on the macroeconomics of inequality

Barany, Zsofia Luca (2011) Essays on the macroeconomics of inequality. PhD thesis, The London School of Economics and Political Science (LSE).

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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.

Item Type: Thesis (PhD)
Additional Information: © 2011 Zsofia Luca Barany
Library of Congress subject classification: H Social Sciences > HB Economic Theory
Sets: Departments > Economics
Supervisor: Caselli, Francesco
URI: http://etheses.lse.ac.uk/id/eprint/157

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