Economic growth and economic development 505

By investing more, workers and symmetrically firms increase the return to capital symmetrically wages, and there is underinvestment because they do not take these external effects into co

Introduction to Modern Economic Growth through prices (not through direct technological spillovers) By investing more, workers (and symmetrically firms) increase the return to capital (symmetrically wages), and there is underinvestment because they do not take these external effects into consideration Pecuniary external effects are also present in competitive markets (since, for example, supply affects price), but these are typically “second order,” because prices are such that they are equal to both the marginal benefit of buyers (marginal product of firms in the case of factors of production) and to the marginal cost of suppliers The presence of labor market frictions causes a departure from this type of marginal pricing and is the reason why pecuniary externalities are not second order

Perhaps even more interesting is the fact that pecuniary externalities in this model take the form of human capital externalities, meaning that greater human capital investments by a group of workers increase other workers’ wages Notice that

in competitive markets (without externalities) this does not happen For example,

in the economy analyzed in the last section, if a group of workers increase their human capital investments, this would depress the physical to human capital ratio

in the economy, reducing wages per unit of human capital and thus the earnings

of the rest of the workers We will now see that the opposite may happen in the presence of labor market imperfections To illustrate this point, let us suppose that there are two types of workers, a fraction of workers χ with ability a1 and 1− χ with ability a2 < a1 Using this specific structure, the first-order condition of firms, (10.39), can be written as

(10.41) (1− λ)

⎡

⎣χ∂F

³ ˆ

k, ˆh1

³

ˆ´´

∂k + (1− χ)

∂F ³ ˆ

k, ˆh2

³

ˆ´´

∂k

⎤

⎦ = R∗,

while the first-order conditions for human capital investments for the two types of workers take the form

∂F³ ˆ

k, ˆhj

³

ˆ´´

0

⎛

⎝

ˆ

hj

³

ˆ´

aj

⎞

⎠ for j = 1, 2

Clearly, ˆh1(k) > ˆh2(k) since a1 > a2 Now imagine an increase in χ, which cor-responds to an increase in the fraction of high-ability workers in the population

491