Infrastructure and inequality

We develop a model in which public capital is both an engine of growth and a determinant of the distributions of wealth, income, and welfare. Government investment increases wealth inequality over time, regardless of its financing. The time path of income inequality is, however, highly sensitive to financing policies, and is often characterized by sharp intertemporal tradeoffs, with income inequality declining in the short run but increasing in the long run. Public investment generates a positive correlation between growth and income inequality along the transition path, but their short-run and long-run relationship depends critically on (i) how externalities impinge on allocation decisions, (ii) financing policies, and (iii) the time period of consideration. Finally, these policies also generate sharp trade-offs between average welfare and its distribution, with government investment improving average welfare, but also increasing its dispersion. Our results are obtained numerically but extensive sensitivity analysis confirms their robustness across key parameter values. (C) 2012 Elsevier B.V. All rights reserved.