Capital Management and Wealth Inequality

Abstract: Wealthier individuals have stronger incentives to seek higher returns. We investigate theoretically the effect this has on long-run wealth inequality. Incorporating capital management into a standard Ramsey-Cass-Koopmans model generates substantial long-run inequality: the majority of the population works and holds no capital, while a small minority holds a large amount of capital and manages it full-time. Counterintuitively, financial innovations or policies that reduce return differentials increase long-run wealth inequality. Egalitarian steady states may exist, but are inefficient and unstable: a small concentration in capital ownership causes a transition to an unequal steady state. Capital management introduces a novel equity-efficiency tradeoff: scale economies make it efficient for a few individuals to manage capital full-time, but under laissez-faire this generates substantial inequality. A utilitarian planner would instead instruct a few individuals to manage capital on behalf of society and transfer most of their income to the workers.

Keywords: wealth inequality; capital; returns; management; information; Financial innovation;

JEL Classification: D31; D83; E21; E22; G51;

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Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2023-09-01

Number: 1072

Note: Revised January 2024.