Inequality of opportunity, inequality of effort, and innovation

Is inequality good or bad for innovation? I study an endogenous growth model with heterogeneous agents; due to credit frictions, inequalities in wealth lead to misallocation of talent. A more unequal reward scheme incentivises innovation in any given period, but it leads to a more unequal distribution of opportunities that may exacerbate the misallocation of talent in the next period. Empirically, I show that the flow of patents in a US state is negatively correlated with inequality of opportunity, but positively with inequality of effort; and that the elimination of state death taxes, as a proxy for an increase in the financial incentives towards risky activities, had a positive short-term but a negative longterm effect on the growth rate of patents.