Factor‐biased public infrastructure and wage inequality

• Author: Jiancai Pi,Pengqing Zhang
• Date: 01 August 2018
• DOI: http://doi.org/10.1111/rode.12393
• Published date: 01 August 2018

REGULAR ARTICLE

Factor-biased public infrastructure and wage

inequality

Jiancai Pi

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Pengqing Zhang

Department of Economics, Nanjing

University, Nanjing, P. R. China

Correspondence

Jiancai Pi, Department of Economics,

Nanjing University, 22 Hankou Road,

Nanjing 210093, P. R. China.

Email: pi2008@nju.edu.cn

Funding Information

The National Social Science Foundation

in China; Grant/Award Number:

16BJY080.

Abstract

This paper analyzes how factor-biased public infrastruc-

ture affects the skilled–unskilled wage inequality. In the

basic model with a full employment economy, we find

that when the weighted dependence of skilled labor and

capital in the urban skilled sector on public infrastructure

is large enough relatively to that of unskilled labor and

capital in the urban unskilled sector, the wage inequality

will be expanded. We also discuss labor-biased and capi-

tal-biased public infrastructure in our framework, and find

that the relative dependences of relevant labor or capital

on public infrastructure are important determinants of

wage inequality. In the extended models, we analyze sep-

arately the issue of wage inequality in the economy with

unemployment and the totally open capital market, and

find the results of the basic model almost still hold.

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INTRODUCTION

The increasing skilled–unskilled wage inequality is an important phenomenon in both developed

and developing countries. Many scholars put forward different theories to explain this phe-

nomenon from different perspectives. The existing explanations can be divided into several

strands, and one of the most important strands stresses the role of governmental behavior and

related institutional arrangements in affecting the wage inequality (e.g., Chaudhuri & Yabuuchi,

2007; Anwar, 2008a–c; Mandal & Marjit, 2010; Pi & Zhou, 2012, 2013, 2014; Anwar & Sun,

2015; Sun & Anwar, 2015; Pi & Chen, 2016; Pi & Zhang, 2016). In this strand of literature,

the role of public infrastructure in widening the wage gap is a prominent focus (see Anwar,

2008a–c; Gupta & Dutta, 2012; Pi & Zhou, 2012, 2014). In the real world, different sectors and

production factors have different dependences on public infrastructure (Lin, 2011). For example,

the industrial parks erected in China, Singapore, and other countries mainly and largely improve

DOI: 10.1111/rode.12393

Rev Dev Econ. 2018;22:e79–e94. wileyonlinelibrary.com/journal/rode ©2018 John Wiley & Sons Ltd

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the investment environment and thus can be considered as capital-biased public infrastructure.

For another example, clean water and sanitation can enhance the level of health and thus

increase worker productivity, and can be seen as labor-biased public infrastructure (e.g., Ag

enor,

2008).

First, we review the literature on public infrastructure. The traditional literature in this direc-

tion usually treats public infrastructure as a public intermediate input or a public good pro-

vided by the public sector (e.g., Meade, 1952; Henderson, 1974; Tawada & Okamoto, 1983;

Tawada & Abe, 1984; Abe, 1990). Pi and Zhou (2014, p. 197) provide a simple survey of

these studies. Meade (1952) and Henderson (1974) divide the public intermediate good into

two kinds. For the first kind, the production function with public infrastructure is linearly

homogeneous with respect to only primary inputs (i.e., capital and labor), and the constant

return to scale is embodied at the industrial level. For the second kind, the production function

with public infrastructure is linearly homogenous with respect to both the primary inputs (i.e.,

capital and labor) and the public input, and the constant return to scale is embodied at the

social level. The treatment of these two types can be referred to Henderson (1974), Tawada

and Okamoto (1983), and Tawada and Abe (1984). However, in these studies, public infras-

tructure in the mathematical sense is sector biased, not factor biased. Factor biasedness means

that public infrastructure has different impacts on different input factors. The role of factor-

biased public infrastructure is supported empirically by the literature on public finance (e.g.,

Hillman, 1978; McMillan, 1979; Feehan, 1989) and theoretically investigated by the literature

on tax competition (e.g., Matsumoto, 1998, 2000, 2004). In contrast to the existing literature,

this paper tries to integrate factor-biased public infrastructure into the framework of skilled–un-

skilled wage inequality.

Second, we review the literature on wage inequality with an eye to public infrastructure. Anwar

(2008a) finds that productive public infrastructure plays an important role in affecting the relative

size of labor inflow induced wage inequality. Anwar (2008b) uses the size of external economies

to reflect the role of public infrastructure, and shows that the magnitude of the long-run effect on

wage inequality depends on public infrastructure. Anwar (2008c) analyzes how the wage rate is

influenced by the labor supply through the channel of public infrastructure. Gupta and Dutta

(2012) explore the effects of capital stock, skilled labor endowment, the tax rate on industrial out-

put, and the price of the agricultural product on wage inequality by taking a sector that produces

public infrastructure into account. Pi and Zhou (2012) show that the production sectors’relative

dependences on public infrastructure play a crucial role in determining the wage gap. Pi and Zhou

(2014) consider the endogenous public infrastructure provision, and find that the comparison of

the capital distributive shares in the urban sectors matters in the case of pure public infrastructure

and the factor substitution elasticities in the urban sectors matter in the case of semi-public infras-

tructure. However, the literature in this direction neglects to take the role of factor-biased public

infrastructure into account. Once factor-biased public infrastructure is considered, we can draw

some different conclusions, but it is largely ignored by the literature on wage inequality. This

paper tries to fill the existing research gap.

Third, the studies most closely related to this paper are Pi and Zhou (2012, 2014). This paper

is very different from their works in the following respects. First, as mentioned earlier, Pi and

Zhou (2012, 2014) focus on the role of public infrastructure at the sector level. In their settings,

the urban skilled and unskilled sectors have different dependences on public infrastructure, and

public infrastructure promotes the sectors’productivities in varying degrees. However, in this

paper, we concentrate on the role of public infrastructure at the factor level. In our settings, differ-

ent factors employed in the urban sectors have different dependences on public infrastructure, and

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