Working Paper 644

Investment-Specific Technological Change, Skill Accumulation, and Wage Inequality

Zheng Liu
Hui He

Revised August 1, 2007

Wage inequality between education groups in the United States has increased substantially since the early 1980s. The relative number of college-educated workers has also increased dramatically in the postwar period. This paper presents a unified framework where the dynamics of both skill accumulation and wage inequality arise as an equilibrium outcome driven by measured investment-specific technological change. Working through equipment-skill complementarity and endogenous skill accumulation, the model does well in capturing the steady growth in the relative quantity of skilled labor during the postwar period and the substantial rise in wage inequality after the early 1980s. Based on the calibrated model, we examine the quantitative effects of some hypothetical tax-policy reforms on skill accumulation, wage inequality, and welfare.

Published In: Review of Economic Dynamics (Vol. 11, Issue 2, April 2008, pp. 314-334)

Download Paper (pdf)