The elasticity of substitution between skilled and unskilled labor in developing countries: A directed technical change perspective

Abstract

I develop a model of endogenous skill-biased technical change in developing countries. The endogenous response to a rise in skill supply counters the traditional substitution effect and dampens supply’s role in reducing wage inequality. The model reinforces consensus estimates of the elasticity of substitution between more/less educated workers by reconciling dispersed existing estimates. It also rationalizes estimates that were hitherto deemed implausible or theory-inconsistent. I produce new estimates for developing countries with a new global panel and with Latin American data (that facilitates analysis of dynamics). Many estimated elasticity values are almost 2. This sheds new light on a parameter that is crucial for inequality, growth, and other key macroeconomic questions.