International factor mobility, elasticity of substitution in production and the skilled–unskilled wage gap

The existing studies have shown that the skilled–unskilled wage gap is affected by the size of elasticity of substitution in consumption. This paper focuses on the role of elasticity of substitution in production. Within the context of this paper, elasticity of substitution in production measures the degree of substitutability between capital and labour. By making use of a two-sector (low-tech and high-tech) general equilibrium model, this paper argues that differences in the degree of substitutability between capital and labour can also affect the size of factor inflow induced skilled–unskilled wage gap. Inflow of capital increases the skilled–unskilled wage gap as long as capital and labour can be relatively easily substituted in the low-tech sector. On the other hand, under the same scenario, inflow of either type of labour decreases the skilled–unskilled wage gap.