Solow and heterogeneous labour: a neoclassical explanation of wage inequality

This paper analyses the effect of human-capital investments of heterogeneous individuals on the dynamics of the wage structure within a neoclassical growth model. The accumulation of physical capital changes relative factor prices and thus incentives to acquire skills, thereby altering the composition of the labour force. Without relying on exogenous shocks, our framework generates dynamics that resemble important observations on wage inequality (e.g., the non-monotone evolution of the skill premium). Additional incorporation of wage rigidities emphasises the trade off between residual wage inequality and employment opportunities for unskilled labour that is consistent with country-specific evidence. Copyright 2004 Royal Economic Society.