Vintage Capital as an Origin of Inequalities∗

Does capital-embodied technological change play an important role in shaping labor market inequalities? This paper addresses the question in a model with vintage capital and search/matching frictions where costly capital investment leads to large heterogeneity in productivity among vacancies in equilibrium. The paper first demonstrates analytically how both technology growth and institutional variables affect equilibrium wage inequality, income shares and unemployment. Next, it applies the model to a quantitative evaluation of capital as an origin of wage inequality: at the current rate of embodied productivity growth a 10-year vintage differential in capital translates into a 6% wage gap. The model also allows a U.S.–continental Europe comparison: an embodied technological acceleration interacted with different labor market institutions can explain a significant part of the differential rise in unemployment and capital share and some of the differential dynamics in wage inequality. ∗We thank Balthazar Manzano, Claudio Michelacci, Gilles Saint-Paul, Chris Pissarides, and Francesco Ricci for their comments and seminar participants at Bank of England, Bank of Italy, Bocconi, Bristol, ESSIM 2000 (Tarragona), Exeter, LSE, NBER Summer Institute 2002, NYU, Pompeu Fabra, Southampton, Tilburg, Toulouse, UCLA. Krusell thanks the NSF for research support. Any opinions expressed are those of the authors and do not necessarily reflect those of the Federal Reserve Bank of Richmond or the Federal Reserve System. For correspondence, our e-mail addresses are: [email protected], [email protected], and [email protected]. †Federal Reserve Bank of Richmond. ‡University of Rochester, Institute for International Economic Studies, and CEPR. §University College London, Institute of Fiscal Studies, and CEPR.