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Fiscal Policy, Sectoral Allocation, and the Skill Premium: Explaining the Decline in Latin America’s Income Inequality

Listed author(s):
  • Juan Guerra-Salas

This paper offers an explanation for the substantial decline in income inequality in Latin America during the 2000s, which is known to have been mainly driven by a decline in the skill premium. The 2000s were characterized by an economic expansion concentrated on low-skill-intensive service sectors. The expansion induced an increase in the demand for low-skilled labor relative to highskilled labor, which compressed the skill premium. Procyclical fiscal policy exacerbated the distributional effects of the boom by contributing to the growth of the service sector. I first document the expansion was concentrated on services while manufacturing lagged behind, and show declining inequality is associated with procyclical fiscal policy. I then rationalize the evidence using a small open economy DSGE model that features a low-skill-intensive nontradable sector relative to the tradable sector, and procyclical government purchases. This framework implies that at least part of the decline in inequality is transitory, a prediction supported by recent data

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 779.

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Date of creation: Feb 2016
Handle: RePEc:chb:bcchwp:779
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