From Childhood to Adult Inequality : Parental Investments and Early Childhood Development

Macroeconomic analysis of inequality and intergenerational mobility typically abstracts from the role of endogenous childhood development. This paper shows that this omission is not innocuous. It extends the standard general-equilibrium heterogeneous-agent life-cycle model with earnings risk and credit constraints to incorporate endogenous early childhood investments (parental time and money), family transfers, and college education. Agents cannot invest in their own childhood development or pay their parents to do so, which can lead to inefficiently low levels of investments. Estimating the model to match key moments of the data (e.g., average childhood investments and returns to skills), we find that a government program that funds early childhood investments would reduce inequality by 20% and improve mobility by 60%, as well as yield a three times larger welfare increase than a government transfer that uses the equivalent revenue. Introducing these investments in the model as a short-run small-scale policy—as in an RCT—would underestimate the benefits by two-thirds. Long-run distribution changes are the main drivers of the differences in welfare and mobility outcomes, while general-equilibrium is important for the reduction of inequality. The paper also shows that by taking a temporary deficit to afford these investments in the transition, the government is able to increase the welfare of every new generation