The Elasticity of Substitution Between Skilled and Unskilled Labor in Developing Countries: A Directed Technical Change Perspective

The Elasticity of Substitution Between Skilled and Unskilled Labor in Developing Countries: A Directed Technical Change Perspective
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Volume/Issue: Volume 2023 Issue 165
Publication date: August 2023
ISBN: 9798400250514
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Labor , Economics- Macroeconomics , Economics / General , Skill-biased technical change , elasticity of substitution , skill premium , inequality , growth accounting , consensus estimates of the elasticity , wage inequality , wage premium , coefficient estimate , Skilled labor , Wages , Unskilled labor , Central America , South America , Caribbean , Global

Summary

We develop a model of endogenous skill-biased technical change in developing countries. The endogenous response to a rise in skill supply counters the traditional substitution effect and dampens its role in reducing wage inequality. The model re-enforces consensus estimates of the elasticity of substitution between more/less educated workers by reconciling dispersed existing estimates. It also rationalizes estimates that were hitherto deemed implausible or model-inconsistent. We produce new estimates for developing countries with a novel global panel (finding values at or just above 2) and with Latin American data that facilitates analysis of dynamics (which reduce estimates to 1.7-1.8). We therefore shed new light on a parameter that is crucial for inequality, growth, and other key macroeconomic questions.