Public Subsidy on Education, Welfare, and Wage Inequality in a Small Open Developed Economy: A Two-period Analysis

As per the conventional wisdom there should be provision for public assistance for skill acquirement for achieving higher economic growth and improving relative wage inequality in the future. However, empirical observations on certain small OECD countries over the period 2000-2011 tell somewhat a different story. The present paper develops a simple two-sector, specific factor general equilibrium framework with endogenous skill formation and provision for public subsidy on education which shows that these atypical empirical observations are theoretically plausible and can possibly be used in examining the data empirically to uncover the reality. The analysis questions the desirability of the policy on the ground that it may not only aggravate inequality in both present and future periods but also does not necessarily improve intertemporal social welfare.