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This essay discusses the effect of technical change on wage inequality. I argue that the behavior of wages and returns to schooling indicates that technical change has been skill-biased during the past sixty years. Furthermore, the recent increase in inequality is most likely due to an acceleration in skill bias. In contrast to twentiethcentury developments, much of thr technical change during the early nineteenth century appears to be skill-replacing. I suggest that this is because the increased supply of unskilled workers in the English cities made the introduction of these technologies profitable. On the other hand, the twentieth century has been characterized by skillbiased technical change because the rapid increase in the supply of skilled workers has induced the development of skill-complementary technologies. The recent acceleration in skill bias is in turn likely to have been a response to the acceleration in the supply of skills during the past several decades.

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I analyze an economy in which pro...t-maximizing ...rms can undertake both laboror capital-augmenting technological improvements. In the long run, the economy looks like the standard growth model with purely labor-augmenting technical change, and the share of labor in GDP is constant. Along the transition path, however, there is capitalaugmenting technical change and factor shares change. A range of policies may have counterintuitive implications due to their eect on the direction of technical change. For example, taxes on capital income reduce the labor share in the short run, but increase it in the medium/long run. Keywords: Economic Growth, Endogenous Growth, Factor Shares, Technical Change. JEL Classi...cation: O33, O14, O31, E25. I thank Manuel Amador, Abhijit Banarjee, Olivier Blanchard, and Jaume Ventura for useful comments. y Massachusetts Institute of Technology, Department of Economics, E52-371, Cambridge, MA 02319; e-mail: daron@mit.edu 1 I.

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We endogenize factor bias and sector bias of technical progress in the 2x2x2 Heckscher-Ohlin framework. International trade affects technology biases by changing the incentive for innovating technologies that complement different factors and sectors. We use the model to investigate the relative-wage effects of trade in final goods, intermediate goods, and technolo-gies, between two countries who both innovate, and between one country who innovates and one country who imitates. Our investigation identifies conditions for the model to explain observed rising wage inequality in developed and less developed countries in recent decades.

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For many problems in macroeconomics, development economics, labour economics, and international trade, whether technical change is biased towards particular factors is of central importance. This paper develops a simple framework to analyse the forces that shape these biases. There are two major forces affecting equilibrium bias: the price effect and the market size effect. While the former encourages innovations directed at scarce factors, the latter leads to technical change favouring abundant factors. The elasticity of substitution between different factors regulates how powerful these effects are, determining how technical change and factor prices respond to changes in relative supplies. If the elasticity of substitution is sufficiently large, the long run relative demand for a factor can slope up.

www.cepr.org Available online at: www.cepr.org/pubs/dps/DP9247.asp www.ssrn.com/xxx/xxx/xxx ISSN 0265-8003

Human capital, technical change and the welfare state