Economic interactions and the distribution of wealth

TL;DR

This paper models wealth distribution in an economy with stochastic productivity, taxes, and redistribution, showing how market completeness and labor market features influence the shape of wealth inequality.

Contribution

It provides an explicit calculation of wealth distribution considering market incompleteness and analyzes how various economic factors affect inequality.

Findings

Top tail of wealth follows a Pareto law only with incomplete capital markets.

Pareto exponent depends on saving rate, net return, growth rate, and diversification.

Labor market characteristics mainly influence the lower tail of wealth distribution.

Abstract

This paper analyzes the equilibrium distribution of wealth in an economy where firms' productivities are subject to idiosyncratic shocks, returns on factors are determined in competitive markets, dynasties have linear consumption functions and government imposes taxes on capital and labour incomes and equally redistributes the collected resources to dynasties. The equilibrium distribution of wealth is explicitly calculated and its shape crucially depends on market incompleteness. In particular, a Paretian law in the top tail only arises if capital markets are incomplete. The Pareto exponent depends on the saving rate, on the net return on capital, on the growth rate of population and on portfolio diversification. On the contrary, the characteristics of the labour market mostly affects the bottom tail of the distribution of wealth. The analysis also suggests a positive relationship between growth and wealth inequality.