A Model of Social Interactions and Endogenous Poverty Traps

Abstract

This paper develops a model of social interactions and endogenous poverty traps. The key idea is captured in a framework in which the likelihood of future social interactions with members of one's group is partly determined by group-specific investments made by individuals. I prove three main results. First, some individuals expected to make group-specific capital investments are worse off because their observed decision is used as a litmus test of group loyalty — creating a tradeoff between human capital and cooperation among the group. Second, there exist equilibria which exhibit bi-polar human capital investment behavior by individuals of similar ability. Third, as social mobility increases this bi-polarization increases. The models predictions are consistent with the bifurcation of distinctively black names in the mid-1960s, the erosion of black neighborhoods in the 1970s, accusations of 'acting white,' and the efficacy of certain programs designed to encourage human capital acquisition.