The process of economic development is characterized by fundamental changes in the structure 2 of production and employment. In historical perspective, the emergence of new and the 3 decline of old industries has led to a dramatic reallocation of resources between sectors of 4 production.1 Despite these huge structural changes, the long-term growth process has been 5 remarkably stable in the aggregate. As mentioned by Kaldor (1961) in his famous stylized 6 facts, a situation where the growth rate, interest rate, capital output ratio, and labor share 7 are constant over time is a reasonable approximation of the long-run growth experience of a 8 modern economy. 9Changes in the structure of production and employment result either from sectoral dif-10 ferences in productivity growth or from sectoral differences in income elasticities of demand. 11This paper focuses on the demand side. In this case, the structural transformation is driven 12 by changes in consumer demand as households get richer. In a poor society, the overwhelming 13 part of income is spent on basic goods, predominantly food. Consequently, the larger part for food, the latter relationship being known as "Engel's law". According to Houthakker 25 1 Maddison (1987) documents the huge reallocation of labor in six major industrialized countries (France, Germany, Japan, Netherlands, U.K. and U.S.). His data show that the average employment share in agriculture was as high as 46.0 % in 1870 and has decreased to 5.5 % by 1984. During the same period the average employment share in the service sector has increased from 26.4 % to 62.2 %.

We introduce non-homothetic preferences into an innovation-based growth model and study how income and wealth inequality affect economic growth. We identify a (positive) price effect-where increasing inequality allows innovators to charge higher prices and (negative) market-size effects-with higher inequality implying smaller markets for new goods and/or a slower transition of new goods into mass markets. It turns out that price effects dominate market-size effects. We also show that a redistribution from the poor to the rich may be Pareto improving for low levels of inequality.

No abstract