Gambling on Education : Investment Skills and Wealth Inequality

We study the link between education and wealth inequality through the channel of financial investment decisions. We present a simple two-period model of individuals endowed with equal wealth and heterogeneous ability in evaluating investment opportunities. Then, the heterogeneous allocation of the initial endowment generates a large concentration of final wealth within the skilled investors. Next, we allow a social planner to supply free education to individuals using taxes on capital income. Education may partially correct the bias regarding the valuation of the investments pay-off, causing wealth inequality across individuals to decline because the fraction of the population that continues to make bad decisions is smaller. The key model insight is that education improves individuals’ evaluation skills and prevents otherwise unskilled investors from making detrimental investment decisions, thus ultimately closing the gap between the top and the bottom tails of wealth distribution. The paper delivers important policy insights regarding how to address the global trend of limited stock market participation and huge wealth inequality observed in the data