Skilled-unskilled wage inequality and structural transformation in a dual economy

In this paper, we develop a sectoral model of a less developed economy with a backward agricultural sector dependent on unskilled labour and with an advanced industrial sector dependent on capital and skilled labour and also with a private education sector whose role is to transform an unskilled labourer into a skilled one. Using a Ramsey framework of consumption saving allocation, we analyse how the economy grows over time through accumulation of capital and through transformation of unskilled labour into skilled labour. Such a model helps us to analyse how the structural shift from agriculture to industry takes place and what role do sector specific polices play in this context. We analyse short-run as well as long run effects of sector specific policies on the degree of wage income inequality as well as on the endogenous rate of economic growth; and find that sector specific policies produce opposite effects. Subsidization to agricultural sector leads to an improvement in the degree of wage income inequality but lowers the rate of economic growth in the long run. On the other hand, subsidization or protection to the manufacturing sector produces just the opposite result.