Trade and wage inequality with endogenous skill formation

Abstract

The present paper develops a two-sector model with one constant returns sector producing basic goods and another increasing returns to scale sector producing fancy goods. A quasi-linear utility function is used to capture the divide between basic and fancy goods. There are two types of productive factors, skilled and unskilled labour, the former working in the skill using fancy goods sector and the latter in the basic good producing sector. Agents differ in their costs of acquiring skill. The model holds possibilities of multiple equilibria and shows that international trade, in spite of equalizing factor prices, also increases the skill premium in all countries.