Inequality And The Dual Economy: Technology Adoption With Specific And General Skills

Slow technology diffusion has important consequences for income inequality. Across countries, it can account for much of world inequality. Within countries, the arrival of new technologies often causes popular concern that the wages of some workers will fall. In developing countries, diffusion is often represented in the stylized form of a “dual economy,” in which a gradually increasing fraction of workers use modern technology, while the remainder use traditional technology. This paper generates this pattern of technology adoption endogenously, and shows that it causes the wages of some workers to fall. Diffusion is slow because production requires both skills that are equally useful with any vintage of technology and skills that are imperfectly transferable across vintages. When these skills are sufficiently specific, a dual economy is optimal, even though intermediate technologies are also available. Workers with transferable skills disproportionately join the modern sector, leaving those with specific skills worse off. As in classical trade models, changes in factor supplies affect the allocation of labor across sectors, but not factor rewards. A dynamic extension shows that workers without transferable skills become worse off throughout the period of transition to the modern technology. A further dynamic extension applies the model to developed countries.