Persistent Inequality

Existing literature explains persistent inequality either by ongoing shocks to abilities or preferences, or by a combination of technological indivisibilities, capital market imperfections and ad hoc assumptions concerning savings behavior. We focus on the role of pecuniary externalities — driven by endogenous movements in relative prices — in explaining both the emergence and persistence of long-run inequality. With imperfect capital markets, it turns out that long-run inequality is inevitable, even if investments are divisible, agents maximize dynastic utility, and there are no random shocks. However, the divisibility of investment does matter in determining the multiplicity of steady states: with perfect divisibility such multiplicity typically disappears. We subsequently characterize efficient steady states, and study non-steady-state dynamics in a two occupation context. We thank Abhijit Banerjee, Michael Kremer, Glenn Loury, Andy Newman and Rajiv Vohra for helpful discussions, and seminar participants at Columbia, Harvard and the July 2000 NBER Income Distribution workshopfor their comments. An Editor and two anonymous referees provided helpful comments on an earlier draft. This research