Educate or Adjudicate? Socioeconomic Heterogeneity and Welfare

I present a formal framework to explore the welfare and distributional effects of a government’s optimal choice over two types of public spending in a closed economy: domestic security (DS) and investment in social capital (SC). Production is characterized as a function of social and physical capital stocks that both vary across the regions. DS stands for total factor productivity, while SC stands for human capital and civic cooperativeness combined. SC accumulates via public spending on universal primary education, cultural, and civic events and such, and is exposed to regional spillover effects. Numerical simulations of the static solution of the government’s welfare maximization problem reveal that the optimal rate of spending on SC (m^*) is negatively related with the income share of physical capital, SC spillovers and fiscal decentralization. Simulations also show that SC homogeneity is positively associated with both the level and equitability of aggregate income. The maximum attainable levels of income, welfare and social cohesion and the most equitable incomes are all observed to realize at some intermediate range of m^* values. In case DS augments SC, however, social cohesion improves and welfare declines monotonously in m^*.