Turbulent Growth and Inquality

This paper develops a theory of income distribution in a growing economy from a search theoretic foundation. It focuses on a 'turbulent' growth process in which individual payoffs from ongoing advance hinge on search effort but are transient in the sense that each successive growth shock outdoes the informational advantage of previous winners. When agents' fortunes are realized in a sequence of growth states, basic results about the distribution of permanent income can be derived from the interplay of the negative effects of turbulence on search effort in each state and its positive effects on income mobility over states. No reference need be made to individual differences in initial circumstances, abilities to accumulate capital, or attitudes towards risk. The major result is that, for a population of (almost) identical agents, as the frequency of growth shocks is increased from zero, the variance of permanent income exhibits an inverted U shape. This implies that an increase in turbulence (from a low initial level) or a decrease in turbulence (from a high level) can both increase long-run equality. The framework also illustrates the deficiencies of both cross-sectional measures of dispersion and the traditional trade-off between growth and equity. In the case where growth leads to the 'democratization of poverty', uniformly high cross sectional variances can coexist with a low variance of permanent income, while mean incomes are falling.