Explaining the Skill Premium: Technical Change or Capita-Skill Complements?

We examine the two-level and the three-level nested four factor Constant Elasticity of Substitution production functions, where labor is disaggregated into skilled and unskilled labor and the capital stock into structures and equipment capital. We estimate inter-factor substitution elasticity and factor-augmenting technical progress parameters. Our special focus of interest is in the issue, whether the source of the observed skill-premium between the wage rates of skilled and unskilled labor is capital-skill complementarity or the skill biased technical change.With several alternative ways to nest the four factors of the production function we derive in the profit maximization framework four-equation systems containing several cross equation parameter constraints. We estimate these systems with the NLSUR estimation method.Our estimation results reject the capital skill-complementarity hypothesis. Instead, our results favour the production function specification, where skilled and unskilled labor are gross substitutes, whilst structures and equipment capital are cross substitutes both with each other and with skilled and unskilled labor. Technical progress is the most strongly biased towards skilled labor explaining the skill-premium between the wage rates of skilled and unskilled labor.