Effort, Talent, and Inequality in a Small Open Economy

We develop a general equilibrium model of a small open economy with performance-pay worker compensation and occupational choice. We analytically and numerically examine the distributional effects of entrepreneurial talent and performance-pay contracts. Risk-neutral, more talented individuals become entrepreneurs, incentivizing workers to exert effort through linear compensation contracts. Entrepreneurial talent and worker effort significantly influence income inequality through complex general equilibrium channels. Economies with higher tariffs, more entrepreneurs, less skilled or more heterogeneous workers, and economies with no worker effort, display higher income inequality measured by the top one percent income share and the Gini Coefficient