Economic growth, skill-biased technical change and wage inequality: A model and estimations for the US and Europe

In recent literature skill-biased technical change has been viewed as a major cause for wage inequality. Some modelling and presentation of stylized facts have been undertaken for US time series data. A preliminary study of wage inequality in a model with knowledge as input in an aggregate production function has been presented by Riddell and Romer General Purpose Technologies and Economic Growth, 1998, MIT Press]. Although some important forces determining wage inequality are widely accepted we know little about the quantitative impact of each source and differences across countries. We present a growth model of the Romer type with innovation-based technical change and two skill groups where the growth of knowledge, the relative supply of the two skill groups, externalities and substitution effects among the two groups are the driving forces for wage inequality. We undertake estimates for US time series data and contrast those estimates with results from some European countries. In particular, we compare parameter estimations for US and German time series data. The paper concludes that there is less wage inequality across skills in Europe in contrast to the US on the macroeconomic level. But, considering disaggregated data we observe some increases in inequality for Germany, too. Although our model reveals important variables for the explanation of wage inequality there may, however, also be other factors, such as trade unions, which have impacted the wage spread.