Factor mobility and skilled-unskilled wage inequality in the presence of internationally traded product varieties

Most existing studies examine the issue of skilled-unskilled wage inequality by using models that are relevant only in the long-run. In addition, studies that utilise product variety models assume that varieties of producer services are non-traded. Using a product variety model, this paper examines the issue of the skilled-unskilled wage inequality when producer services are internationally traded. The paper shows that, irrespective of the size of income share of capital, inflow of capital (which can also be interpreted as foreign direct investment) has no effect on skilled-unskilled wage inequality in the short-run. However, in the long-run, inflow of capital can decrease the skilled-unskilled wage inequality. An increase in the price of the agricultural good can decrease the skilled-unskilled wage inequality in the short-run.