Lifetime Network Externality and the Dynamics of Group Inequality

The quality of one's social network significantly affects his economic success. Even after the skill acquisition period, the social network influences economic success through various routes such as mentoring, job searching, business connections, or information channeling. In this paper I propose that a social network externality which extends beyond the education period -- what I call a Lifetime Network Externality -- is important in explaining the evolution of between-group inequality in an economy. When the members of a group believe that the quality of their social network will be better in the future, more young group members invest in skill achievement because they expect higher returns on investment realized over the working period. As this is repeated in the following generations, the quality of the group's network improves over time. Combining the Lifetime Network Externality, which operates during the labor market phase of a worker's career, with the traditional concepts of peer and parental effects, which operate during the educational phase (Loury 1977), I suggest a full dynamic picture of group inequality in an economy with multiple social groups. I define a notion of Network Trap, wherein a disadvantaged group cannot improve the quality of its network without a governmental intervention, and I explore the egalitarian policies to mobilize the group out of this trap. This social capital approach suggests a positive effect of equality on economic growth in later stages of economic development and a positive effect of inequality in the early stage of economic development, consistent with Galor and Zeira (1993). Unlike the previous literature, the conclusion is derived without imposing the standard assumption of credit market imperfections. Therefore, this implies that equality, by helping disadvantaged groups to move out of the network trap, has a positive effect on economic development even in a matured economy without binding credit constraints, or in a society with public provision of schooling.