The cyclicality of income distribution and innovation induced growth

This paper demonstrates the countercyclicality of income inequality. Inferences are drawn from a unique model that combines a new Keynesian framework with an endogenous growth mechanism that features a labor-augmenting technology. The income disparity is between high-skill workers who service firms’ R&D activities and low-skill workers who contribute to output via a standard neoclassical function. Successful R&D activities increase firms’ knowledge stock that in turn augments low-skill workers’ efficiency and the trend growth rate of the economy. Both a reasonable calibration of the model and a Bayesian estimation exercise demonstrate that the share of high-skill workers’ income is countercyclical and that demand and price shocks are the drivers of this cyclicality. The reason is that the marginal product of high-skill workers is larger in magnitude and this renders the demand for their services less sensitive to shocks. In particular, firms require relatively smaller adjustments in this type of labor to match the changes in the demand for their goods. The disparity in demand for the two types of labor then implies that the high-skill/low-skill wage gap increases during recessions and decreases during expansions.