Wage Inequality, Outsourcing, and Education

We present a simple model to explain why wage inequality in the U.S. increased in the 1980s but decreased in the 1970s, in which we argue that educational investment might deteriorate wage inequality temporarily, but permanently decrease it. A country would not necessarily present the Kuznets inversed-U curve if having sufficient educational investment. Acceleration in the educational investment rate leads to an increasing supply of skilled labor and temporarily generates a higher technology growth rate, which might deteriorate the wage inequality in transition. In the new equilibrium, the wage inequality is permanently decreased because the relative supply of skilled labor increases to a higher level while technology returns to its balanced growth rate. However, the temporary acceleration in educational investment is at the expense of current consumption, which is not a tradeoff preferred by every nation.