Labor market distortion and its impact on wage inequality in the modernization of small-scale agriculture

This study investigates the impacts of labor market distortion on wage inequality by considering the modernization of small-scale agriculture. Owing to small-scale operations, agriculture requires an intermediate sector—an agricultural producer service sector—to facilitate the introduction of nonagricultural intermediate inputs and promote modernization. The basic model assumes perfect competition in the service sector and shows that if the elasticity of substitution between labor and services is sufficiently large (small), mitigating distortion widens (reduces) wage inequality between skilled and rural unskilled labor. In the extended model, we introduce a service sector with monopolistic competition and the main results of the basic model almost hold.