This paper reviews the evidence from recent research that addresses the origins of
inequality and the evolution of the capabilities that partly determine inequality. Both cognitive and noncognitive capabilities are important in producing a variety of outcomes.
An emerging literature relates psychological measurements of personality and
cognition to economic preference parameters and extends conventional preference specifications in economics.
Comparative advantage is an empirically important feature of economic and social
life. The same bundle of personal traits has different productivity in different tasks. Recent
empirical work on the technology of capability formation provides an operational
empirical framework. Capabilities are not invariant traits and are causally affected by
parental investment. Genes and environments interact to determine outcomes. The
technology of capability formation rationalizes a large body of evidence in economics,
psychology, and neuroscience. Capabilities are self-productive and cross-productive.
Dynamic complementarity explains why it is productive to invest in the cognitive skills
of disadvantaged young children but why the payoffs are so low for cognitive investments
in disadvantaged older children and are even lower for disadvantaged adults.
There is no equity-efficiency trade-off for investment in the capabilities of young disadvantaged
children. There is a substantial equity-efficiency trade-off for investment in
the cognitive skills of disadvantaged adolescents and adults. The trade-off is much less
dramatic for investment in the noncognitive skills of adolescents. Parental environments
and investments affect the outcomes of children. There are substantial costs to
uninhibited libertarianism in one generation if the preferences and well-being of the
next generation are ignored41.
The preferences, motivations, and skill endowments of adults that are created in
part in their childhoods play important roles in creating inequality. They can be influenced,
in part, by policy. But incentives matter too. Society can reduce crime and promote
well-being by operating at both incentive and investment margins.
The right mix of intervention to reduce inequality and promote productivity remains
to be determined. The optimal timing of investment depends on the outcome
being targeted. The optimal intervention strategies depend on the stage of the life cycle
and endowments at each stage. For severely disadvantaged adults with low levels of
capabilities, subsidizing work and welfare may be a better response for alleviating poverty
than investment in their skills. The substantial heterogeneity in endowments and
effects of interventions at different ages suggests that a universal policy to combat the
adverse effects of early disadvantage is not appropriate. Optimal investment should be
tailored to the specifics that create adversity and to the productivity of investment for
different configurations of disadvantage. As research on the economics of capability
formation matures, economists will have a greater understanding of how to foster successful