We show that path dependency in economic development can emerge in a model where social distance affects capital accumulation. This effect works through the impact of social interactions on individuals’ incentives to invest. Social distance evolves intergenerationally, as the process of social interactions with people from different backgrounds generates familiarity and experiences that are bequeathed to the next generation, thus shaping their perceptions and opinions about “outsiders.” A key result is the possibility of alienation among people who belong to different groups, if social distance is above a threshold. The initial conditions with respect to social distance and the capital stock can both be critical in determining the economy’s long-term prospects.
