Skilled–unskilled wage inequality, product variety and unemployment: A static general equilibrium analysis

Abstract

The paper develops a three-sector small open economy model with two traded final good sectors and a nontraded good sector producing varieties of intermediate goods. There are three primary factors: capital, skilled labour and unskilled labour. Industrial sector producing a tradedgood uses capital, intermediate goods and skilled labour as inputs. Intermediate goods producing sector also uses capital and skilled labour. The efficiency wage hypothesis is introduced to explain unemployment in each of these two labour markets. It is shown that an increase in either type of labour endowment (capital endowment) raises (lowers) the unemployment rate of either type of labour if the scale elasticity of output is very low. On the other hand, if the industrial sector is more capital intensive than the agricultural sector and if efficiency functions of both types of labour are identical, then an increase in either type of labour endowment (capital endowment) lowers(raises) the skilled–unskilled wage ratio. However, the effect of a change in capital endowment on the Gini Coefficient of wage income distribution is ambiguous in sign.

Keywords:

• skilled labour
• unskilled labour
• wage inequality
• unemployment
• efficiency wage hypothesis
• increasing returns
• product variety
• Gini Coefficient

JEL Classifications:

• F13
• F22
• J31
• O15

Notes

 1. According to Bound and Johnson (1992), Leamer (2000), Marjit and Acharyya (2003), etc., growing income inequality is experienced in US between 1960s and 1970s; and Lawrence (1994), Katz, Loveman and Blanchflower (1992), etc. point out the same problem in European countries between 1978s and 1988s.

 2. According to Wood (1997), Dev (2000), Borjas and Ramey (1993), Banga (2005), Beyer, Rojas and Vergara (1999), etc., wage inequality has increased in many Latin American and South Asian countries in the mid-1980s.

 3. According to Wood (1998), Beyer, Rojas and Vergara (1999), Green, Dickerson and Arbache (2001), Behrman, Birdsall and Szekely (2000), Isgut (2001), etc., trade liberalization is to blame for this growing wage inequality. However, Wood (1997, 1998), Dev (2000) and Gorg and Strobl (2002) are of the view that technological progress worsens wage inequality through an increase in the relative demand for skilled labour. Esquivel and Lopez (2003) show that the technological change aggravates but trade liberalization lowers wage inequality in Mexico.

 4. See Feenstra and Hanson (1997) in this context.

 5. See Harrison and Hanson (1999), Hanson and Harrison (1999) and Beyer, Rojas and Vergara (1999) in this context.

 6. See Wood (1997) in this context.

 7. See, for example, Acemoglu (1998, 1999, 2002a,b), Kiley (1999), Wang, Fang and Huang (2009), Fang, Huang and Wang (2008), etc.

 8. See, for example, Beladi, Chaudhuri and Yabuuchi (2008), Chaudhuri and Yabuuchi (2007, 2008), Chaudhuri (2004, 2008), Marjit and Kar (2005), Yabuuchi and Chaudhuri (2007), Marjit and Acharyya (2003), Marjit (2003), Xu (2003), Marjit, Beladi and Chakrabarti (2004), Marjit and Acharyya (2006), Kar and Beladi (2004), Zhu and Trefler (2005), Gupta and Dutta (2010a, 2010b), etc.

 9. See, for example, Glazer and Ranjan (2003), Anwar (2001, 2006a, 2006b, 2009), Anwar and Rice (2009), etc.

10. See Table 2.2 in page 11 of Marjit and Acharyya (2003).

11. See Table 2.11 in page 31 of Marjit and Acharyya (2003).

12. The literature on efficiency wage hypothesis include works of Solow (1979), Copeland (1989), Agell and Lundborg (1992, 1995), Feher (1991), Akerlof and Yellen (1990), etc.

13. Gupta and Dutta (forthcoming) have also considered Gini Coefficient of wage income distribution as a measure of wage inequality. But, they have considered unemployment of both types of labour in a competitive general equilibrium model.

14. See, for example, works of Agell and Lundborg (1992, 1995), Gupta (2000), Gupta and Gupta (2001) and Chaudhuri and Banerjee (2010).

15. Our efficiency function is a special case of the more general efficiency function considered in the fair wage hypothesis developed by Agell and Lundborg (1992, 1995), where rental rate on capital also appears as an argument. Chaudhuri and Banerjee (2010) use this more general efficiency function.

16. Derivations of equations (18)–(20) are given in the Appendix.

17. Derivations of equations (21) and (22) are given in the Appendix.

18. Derivation of equation (29) is given in the Appendix.

19. Derivation of equation (30) is given in the Appendix.

20. See, for example, Chaudhuri and Banerjee (2010).

21. See, for example, Chaudhuri and Banerjee (2008).

22. See, for example, Chaudhuri and Banerjee (2008, 2010).