Abstract
This paper explores the long-run relationship between institutions and wage inequality in Europe and its periphery using a two-sector model. When institutions improve, wages rise across the board, thus reducing the costs of rural-urban migration and skills acquisition relative to the expected urban wage. The subsequent increase in the supply of urban craftsmen can in turn lead to a narrowing of the relative gap between skilled and unskilled wages. These predictions are borne out by the historical data. Cities with stronger institutions experienced: (i) higher skilled and unskilled real wages, and (ii) lower levels of urban inequality, as measured by the skilled-unskilled wage ratio.
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