Skill formation, public expenditure on education and wage inequality: theory and evidence

As per the conventional wisdom there should be provision for public assistance for skills acquirement for improving relative wage inequality in the future. Empirical observations on some prominent small OECD countries, however, indicate that the relationship between wage inequality and public spending on education is not necessarily unambiguous. A theoretical underpinning of this empirical observation has been provided in this study in terms of a 2×3 general equilibrium model for a small open economy. Later, the correctness of the theoretical framework and its result have been empirically examined with the help of an unbalanced panel dataset of 13 small developed countries from 2000-2011. This empirical analysis supports the main theoretical result that the relationship between wage inequality and public expenditure could indeed be ambiguous. This finding questions the desirability of providing subsidy on education at least from the perspective of reduction in earnings inequality among the different sections of the working population.