Tax policy and human capital accumulation in a resource constrained growing dual economy

Abstract

This paper examines the role tax policy can play in fostering human capital accumulation in a resource constrained dual economy whose population is growing. The study shows how human capital accumulation, in turn, affects intersectoral terms of trade and the economic growth process of a dual economy. The dual economy is assumed to consist of two basic sectors, agriculture and manufacturing. Production in agriculture requires unskilled labor and capital whereas production in the manufacturing sector requires skilled and unskilled labor and capital. Schooling facilities are limited and access is rationed by the government. Moreover, schooling requires an investment of time. The paper demonstrates the existence of a unique short run equilibrium. It also demonstrates that the steady state equilibrium is unique and locally stable. Comparative steady state analysis suggests that a balanced budget increase in public investment in education (financed by a tax increase on capital income and/or incomes of skilled workers), alters the terms trade between agriculture and manufacturing sectors and favorably affects the economic growth process.