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

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 investmentspecific 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. ∗He: Department of Economics, University of Hawaii; E-mail: [email protected]. Liu: Department of Economics, Emory University; E-mail: [email protected]. We thank V.V. Chari, Larry Jones, Michele Boldrin, Nobu Kiyotaki, and Narayana Kocherlakota for helpful comments. We are grateful to Gianluca Violante for providing his data. Liu wishes to thank the Federal Reserve Bank of Minneapolis and the University of Minnesota for their hospitality. The views expressed herein are those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of Minneapolis or the Federal Reserve System.