to increase in developing and decrease in industrialized countries with deepening globaliza-
tion. Conversely, the returns to high-skilled labor will decrease in developing and increase in
industrialized countries with globalization.
Consequently, we need to account for this argument, which resembles the factor price
equalization theorem from the Heckscher-Ohlin model, in our model. We do this by modeling
the price at which the output of individual i can be sold as a function of globalization, which
we denote with A. The price for the output of an individual i of type I = {L,H} is thus
given as pi = pi [A]. We assume that pH > pL holds both in industrialized and developing
countries. What diers in our model between industrialized and developing countries is the
sign of dpi/dA, the (marginal) effect of globalization on the output prices. It follows from our
previous discussion that dpH/dA > 0 and dpL/dA < 0 holds for industrialized countries. In
developing countries, the signs should be reversed, i. e., dpH/dA < 0 and dpL/dA > 0. While
this is admittedly a highly simplied application of the insights from the Heckscher-Ohlin
model,5 it captures the important result that international trade leads to a equalization of
factor prices (Krugman and Obstfeld, 2005).
The market income of the individual i is then given by
πi = pi[A]yi = pi[A]aβ g1i-β, ∀i ∈ I = {L,H}. (1)
Even though taxes can in principle only be collected after production has taken place, it
is reasonable to assume that education expenditures are nanced through taxation because
any productivity enhancing government expenditures have to be paid eventually through tax
revenue.6
The government’s budget constraint is given by
T = M(L) gL + gH + R. (2)
This equation states that a share T — R of total tax revenues T is intended for education
expenditures. The remaining portion R > 0 of the tax revenues is used for redistribution
through cash transfers.
Since the low-ability individuals constitute the majority of the population, we assume that
the government is exclusively interested in the welfare of this population group. This is a
reasonable approximation of reality for democratic countries, and it might also be appropriate
for certain types of autocratic states such as populist regimes.
We equate the welfare of an individual with her net-consumption level. The government
has, in principle, two decision variables through which it can inuence an individual’s net-
5 In the standard exposition of the Heckscher-Ohlin model, for example, international trade leads only
indirectly to an equalization of factor prices by causing a convergence of prices for traded goods. In our model,
however, we do not distinguish between factor and output prices for the sake of brevity. See Krugman and
Obstfeld (2005) and Leamer (1995) for a more detailed discussion of the Heckscher-Ohlin model.
6See Alesina and Rodrik (1994) for a similar approach.