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 1980–1997 period in terms of changes in factor endowments. This result has implications for how policy makers might react to rising skill premiums.