Intermediate goods-skill complementarity and income distribution

The income share disparity between skilled and unskilled labor has been previously analyzed in relation to the elasticity of substitution between these factors and capital and changes in skill-biased technological changes. This study analyzes how the expansion of intermediate inputs affects change in the shares of skilled and unskilled labor, which has not been sufficiently analyzed in previous studies. After estimating the elasticity of substitution between four production factors, skilled labor, unskilled labor, capital, and intermediate goods, an analysis using a four-factor dynamic stochastic general equilibrium (DSGE) model with a three-level nested constant elasticity of substitution (CES) production function and factor-biased technological changes was conducted. It demonstrated that the characteristic change in the labor share was mainly related to changes in relative prices between intermediate goods and other factors and the intermediate goods-skill complementarity, which reflects the low elasticity of substitution between intermediate goods and skilled labor. The change in relative prices among production factors and elasticities of substitution are the main drivers of changing income distribution. In contrast to previous studies, our model allows the gross output and value-added deflators to move differently and thus could clarify the mechanism of the changing labor shares.