Rising wage inequality and capital-skill complementarity

Abstract

Increased wage inequality has been a sensitive policy issue in OECD economies in recent decades. A shortcoming in the literature investigating its causes, especially with regard to the role of new technology, is that technical change is commonly determined residually. We address this limitation by specifying a computable general equilibrium (CGE) model that identifies four labour types and three capital assets. When capital assets are measured in efficiency units and there is capital-skill complementarity, we can explain a large component of the increase in UK wage inequality over the 1980-97 period in terms of changes in factor endowments. This result has implications for how policy makers might react to rising skill premiums.