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Capital-Skill Complementarity and Inequality Over the Business Cycle

  • Matthew J. Lindquist

    (Stockholm University)

When capital-skill complementarity is present in the production process, changes in the skill premium are driven not only by changes in the ratio of unskilled- to skilled labor inputs (as they are in the case with Cobb-Douglas production), but also by changes in the capital-skill ratio. A simple regression analysis demonstrates that the capital-skill ratio has a positive and significant relation to the skill premium at business cycle frequencies as predicted by the capital-skill complementarity hypothesis. This finding motivates the construction of a stochastic dynamic general equilibrium model which allows for capital-skill complementarity in production. The model with capital-skill complementarity can account for the cyclical behavior of the skill premium and much of its volatility. The model without capital-skill complementarity cannot. These results, together with the available empirical evidence, suggest that capital-skill complementarity is an important determinant of wage inequality over the business cycle. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/j.red.2003.11.001
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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 7 (2004)
Issue (Month): 3 (July)
Pages: 519-540

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Handle: RePEc:red:issued:v:7:y:2004:i:3:p:519-540
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