Investigating how meritocracy enables economic growth
Socioeconomic inequality is on the rise across the globe, yet research suggests that citizens in unequal societies characterized by greater inequality are generally less concerned about inequality than those in more egalitarian societies. One possible explanation for this is that people may be more likely to accept inequality if they believe that societal success reflects a meritocratic process, rather than institutional disadvantages.
This research seeks to answer the question of how meritocracy influences people’s behaviours, whether it hinders or promotes economic growth, and whether it deepens the inequality gap. The authors investigate the effects that meritocracy has on agents’ consumption choices, effort choices and ensuing equilibrium asset prices.
The paper constructs a heterogeneous agent continuous-time model that includes both consumption choice and effort choice. In this model, an agent’s share of the economic pie is determined by their effort and socioeconomic class, as well as how meritocratic the society is. In an unmeritocratic economy, an agent’s share of the pie depends more on their socioeconomic class; while in a meritocratic economy their share depends more on their effort. The authors include a preference for meritocracy, independently distributed innate ability, and low and high socioeconomic class in their design.
The concept of meritocracy has received remarkably little attention in the economics literature. Understanding the mechanism through which meritocracy affects individual effort choices and consumption choices, as well as country-level economic growth and asset prices, can guide welfare, improve policy decisions and help us build better societies.
The potential impact
This research is the first to investigate how real-world meritocracy affects people’s consumption choices, effort choices and financial markets. It offers a new channel to help explain cross-country differences in interest rates and equity risk premiums. Understanding these channels can help better inform policy interventions at the state level.
The paper sheds light on how meritocracy affects inequality in both developed and developing countries, and bolsters the analysis by considering a century-old dataset to test whether meritocracy has similar effects over time. The model also investigates how mobility benefits overall economic growth and equity returns.
Co-author
Suleyman Basak, Professor of Finance, London Business School
Acknowledgement
The Wheeler Institute has awarded funding to Darcy Pu and Valeria Fedyk’s research for its business contribution to development in the developing world. Eligible applicants applied for research funding up to £20,000.
Darcy Pu is a PhD candidate in Finance at London Business School. His research interests include theoretical and empirical asset pricing, ESG, information economics, market microstructure, and asset management. Prior to joining LBS in 2018, Darcy earned a BA (First-Class Honours) at Guanghua, Wharton and SNU Business School from 2015 to 2018. He also gained work experience in several investment banks, a private equity house, and a hedge fund in London, Beijing and Seoul.
Valeria Fedyk graduated from Stanford with a double major in Economics with Honors and Mathematics. Following graduation, Valeria worked at J.P. Morgan and in a research and product-management capacity at AQR Capital Management, and she hopes to utilise some of her industry experience in her research. Coming into the Finance PhD programme, Valeria is most excited about theoretical and empirical asset pricing, asset management, and behavioural finance areas of research. Valeria holds CFA and CAIA financial certifications.