Does the Dispersion of Skills Explain Inequality in Market Labor Income? An Analysis From Occupational Choice Models

This paper examines the relationship between the dispersion of general skills in the working population, and inequality in the distribution of labor income that arises from the market equilibrium from occupational choices. In general, more skilled individuals earn higher labor income in the equilibrium, and the relationship between skills and income is proportional in the occupational group of employees, but labor income increases more than proportionately with skills in the groups of solo self-employed and entrepreneur-managers. Labor income inequality at the economy level is then the result of combining the distribution of skills with the sizes of occupational groups. This paper helps to explain some apparent contradictions between the theory, which predicts a close association between dispersion of skills and labor income inequality, and the empirical evidence, using data from the PIAAC project, of no correlation between dispersion of skills and wage inequality in cross-country data.