The Decline in Capital-Skill Complementarity

By Gonzalo Castex, Stanley Cho and Evgenia Dechter

We revisit the capital-skill complementarity hypothesis and examine whether and under what conditions this mechanism can explain the developments in wage inequality and labor share in the 1963-2016 period. Krusell, Ohanian, Rios-Rull, and Violante (2000) show that a model with capital-skill complementarity mechanism matches the data well and can account for the changes in wage inequality in the 1963-1992 period. We show that applying the model to the 1963-2016 period delivers a good fit for the skill premium; however, it does not predict the declining pattern in labor share in the last two decades. We modify the model to allow for a flexible technology structure and show that the degree of capital-skill complementarity is declining over time. The model with time-varying capital-skill complementarity can match the changes in skill premium and labor share in the 1963-2016 period.

This shows that replication is important, not only to verify the original results are valid, but also to see whether they remain valid with more recent data or along dimensions that have come to prominence since the original study.


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