Socioeconomic inequality is on the rise across the globe, yet research suggests that citizens in unequal societies characterised by greater inequality are generally less concerned about inequality than those in more egalitarian societies. One possible explanation for this is that people may be more likely to accept inequality if they believe that societal success reflects a meritocratic process, rather than institutional disadvantages.

This research seeks to answer the question of how meritocracy influences people’s behaviours, whether it hinders or promotes economic growth, and whether it deepens the inequality gap. The authors investigate the effects that meritocracy has on agents’ consumption choices, effort choices and ensuing equilibrium asset prices.

The paper constructs a heterogeneous agent continuous-time model that includes both consumption choice and effort choice. In this model, an agent’s share of the economic pie is determined by their effort and socioeconomic class, as well as how meritocratic the society is. In an unmeritocratic economy, an agent’s share of the pie depends more on their socioeconomic class; while in a meritocratic economy their share depends more on their effort. The authors include a preference for meritocracy, independently distributed innate ability, and low and high socioeconomic class in their design.

This research is the first to investigate how real-world meritocracy affects people’s consumption choices, effort choices and financial markets. It offers a new channel to help explain cross-country differences in interest rates and equity risk premiums. Understanding these channels can help better inform policy interventions at the state level.

The paper sheds light on how meritocracy affects inequality in both developed and developing countries, and bolsters the analysis by considering a century-old dataset to test whether meritocracy has similar effects over time. The model also investigates how mobility benefits overall economic growth and equity returns.