Full Terms & Conditions of access and use can be found at https://www.tandfonline.com/action/journalInformation?journalCode=rjte20 Journal of International Trade & Economic Development ISSN: 0963-8199 (Print) 1469-9559 (Online) Journal homepage: https://www.tandfonline.com/loi/rjte20 Rising wage inequality in developing economies: Privatization and competition Chi-Chur Chao , Bharat R. Hazari & Eden S. H. Yu To cite this article: Chi-Chur Chao , Bharat R. Hazari & Eden S. H. Yu (2006) Rising wage inequality in developing economies: Privatization and competition, Journal of International Trade & Economic Development, 15:3, 375-385, DOI: 10.1080/09638190600871719 To link to this article: https://doi.org/10.1080/09638190600871719 Published online: 18 Feb 2007. Submit your article to this journal Article views: 128 View related articles Citing articles: 4 View citing articles Rising Wage Inequality in Developing Economies: Privatization and Competition CHI-CHUR CHAO*, BHARAT R. HAZARI** & EDEN S. H. YU** *Department of Economics, Chinese University of Hong Kong, Hong Kong and Department of Economics, Oregon State University, USA, **Department of Economics and Finance, City University of Hong Kong, Hong Kong A BSTRACT Using a dual structure depicting a developing economy, this paper shows that increased partial privatization or foreign competition can lead to wage inequality between skilled and unskilled labor. In addition, rising wage inequality can be triggered by inflows of unskilled labor or outflows of skilled labor and/or capital. Further, partial privatization or foreign competition reduces the urban output, thereby raising the goods price and unemployment ratio. These effects lower social welfare of the economy. K EY W ORDS : Wage inequality, privatization, competition, developing economies Introduction The ‘Iron Lady’ Baroness M. Thatcher is the mother of moves towards privatization throughout the world. In many countries, even supposedly left wing parties sold public assets to the private sector. The labor government in Australia privatized banks and airlines. The Marxist government in Bengal India also privatized many public assets. In addition to privatization, the world has also witnessed the delivery of a more liberal market oriented agenda in many countries after the collapse of the Communist regimes. The rise of globalization and liberal reforms has been closely connected with trade reforms in many developed and developing countries. In spite of such movements towards privatization and trade reforms, very few studies have been undertaken to assess the impact of such movements on wage inequalities. It should be noted that both privatization and trade reform alter the rules by which firms are managed and governed and also have an impact on the nature of markets in which firms operate. Correspondence Address : Bharat R. Hazari, Department of Economics and Finance, City University of Hong Kong, Kowloon, Hong Kong. E-mail: bhazari@gmail.com J. Int. Trade & Economic Development Vol. 15, No. 3, 375 – 385, September 2006 ISSN 0963-8199 Print/1469-9559 Online Ó 2006 Taylor & Francis DOI: 10.1080/09638190600871719 Wage inequality between skilled and unskilled labor has been the focus of attention of many studies. In the literature, the skill premium can be primarily attributed to trade and technology: 1 the increase in the wages of the skilled workers being associated with skilled-biased technological progress, while the falling wage of the unskilled workers is linked to cheaper imports of unskilled-labor-intensive goods or outsourcing of unskilled-labor-intensive stages abroad. 2 The analyses of skill premium mainly focus on product restructuring towards skill-biased technologies, often noticed in advanced economies. Nonetheless, for developing economies, rising wage inequality may also be caused by a different set of factors, such as distortions, both autonomous and/or policy induced. Recently, some studies have emerged on skill formation and wage inequality for developing economies; for example, Davis (1998) attributes wage inequality to unemployment, Kar and Beladi (2004) to migration, and Feenstra and Hanson (1997) and Marjit et al . (2003) to foreign direct investment. These studies mainly concentrate on market distortions and the associated factor mobility. However, the impacts of economic policies and reforms on relative wages of the skilled and unskilled workers in developing countries have by and large not been addressed. In this paper we address these issues by focusing on the following two questions: does privatization cause rising wage inequality in developing countries? And does increased foreign competition increase relative wage dispersion? 3 This paper is organized as follows. The next section provides a model of a dual economy relevant to many developing economies, in which a state- owned monopolistic firm operates in the urban sector, while the firms in the rural sector are competitive and privately owned. Using this model, the effects of privatization and competition on the wages of the skilled and unskilled are examined in the third section. This is followed by an analysis of welfare implications of such reforms in the fourth section. The final section contains concluding remarks. The Model We consider a developing economy that consists of two regions: urban and rural. A partially state-owned firm in the urban area produces manufac- turing good X , while competitive privately-owned firms in the rural area produce the agricultural good Y . The country exports good Y and imports good X . There are no impediments for the exports, but to protect the state- owned firm the government imposes a quota Q of good X on foreign exporters. Choosing good Y as the numeraire, the domestic relative price of good X is denoted by p Denoting domestic consumers’ demand for the two goods by D X and D Y , the utility function is represented by the following quasi-linear utility func- tion: U ( D X , D Y ) ¼ u ( D X ) þ D Y , where u 0 ( D X ) 4 0. Letting I denote income, utility maximization subject to the budget constraint, I ¼ pD X þ D Y , yields 376 C.-C. Chao et al. the inverse demand function for good X : p ¼ p ( D X ), with p 0 5 0, and the indirect utility function is: V ¼ V ( p , I ), with V p ¼ 7 D X and V I ¼ 1. In equilibrium, demand for good X meets its supply from domestic production and imports, i.e. D X ¼ X þ Q It is appropriate now to examine the production side of the economy. In the urban sector, the state-owned monopolistic firm produces good X under increasing returns to scale: skilled labor along with capital is required for the needed fixed inputs, while unskilled labor and capital are used as variable inputs in production. Letting F ( ) and m ( ) be the fixed and marginal costs, total cost for producing good X is: C ( w U , w S , r , X ) ¼ F ( w S , r ) þ m ( w U , r ) X , where w U and w S are respectively the urban unskilled and skilled wages, and r is the capital rental rate. By the envelope property, the employment of skilled labor, unskilled labor and capital in sector X are: S ¼ F w ( w S , r ), L X ¼ m w ( w U , r ) X and K X ¼ F r ( w S , r ) þ m r ( w U , r ) X , where the subscript represents the partial derivative. Since the firm in sector X is state-owned, it cares not only for profits but also for the welfare generated. The profit of firm X is: p ¼ p ( X þ Q ) X – C ( w U , w S , r , X ), and welfare is the sum of the profit and consumer surplus: W ¼ p þ CS , where CS ¼ u ( X þ Q ) – p ( X þ Q ) X . Therefore, the objective of the firm is to maximize a weighted average of profits and welfare, k p þ (1 – k ) W , where k 2 [0, 1]. 4 Here, the weight k represents the degree of private ownership: the firm is fully state-owned when k ¼ 0, whereas it is completely private-owned when k ¼ 1. Hence, a larger value of k denotes a higher level of private ownership. 5 The firm chooses the level of output X to maximize the objective function already postulated, and the first-order optimality condition is: p ð X þ Q Þ þ kp 0 ð X þ Q Þ X ¼ m ð w U ; r Þ ð 1 Þ where the two terms on the left-hand side show the marginal revenue (MR) of producing good X . Equation (1) is interpreted as follows. For the fully state-owned firm ( k ¼ 0), marginal cost pricing follows from equation (1) and the firm behaves competitively (i.e. p ¼ m ). When partial privatization takes place ( k 4 0), we have p 4 m because p 0 ( ) 5 0. This causes the MR curve to shift downward for a larger k . In addition, the direct effect of a rise in Q on MR is: @ MR/ @ Q ¼ (1 þ kes ) p 0 , where s ¼ X /( X þ Q ) 5 1 and e ¼ ( X þ Q ) p 00 / p 0 > < 0. By the stability condition, 1 þ es 4 0 as shown in the appendix, we have @ MR/ @ Q 5 0. This implies that increased foreign competition due to a relaxation of quotas also causes the MR curve of the domestic firm to shift downward. 6 Besides the welfare consideration, the state-owned urban firm also sets, for unskilled labor only, a minimum wage, which exceeds the unskilled labor wage in the rural sector. The higher urban wage leads to rural- urban migration of unskilled workers, thereby resulting in urban unemploy- ment, L u Defining the unemployment ratio of unskilled workers in Rising Wage Inequality in Developing Economies 377 the urban sector by m ¼ L u / L X , the Harris – Todaro (1970) migration equili- brium is: w U = ð 1 þ m Þ ¼ w R ; ð 2 Þ where w R is the rural unskilled wage and 1/(1 þ m ) expresses the probability to find a job by unskilled workers in the urban area. Equation (2) simply states that in equilibrium, the expected urban unskilled wage equals the rural unskilled wage. As far as the production of good Y is concerned, it requires unskilled labor and capital under constant returns to scale. The corresponding unit cost function is denoted by g ( w R , r ), and the demands for unskilled labor and capital are: L Y ¼ g w ( w R , r ) Y and K Y ¼ g r ( w R , r ) Y . Under perfect com- petition, unit cost equals the price of good Y : g ð w R ; r Þ ¼ 1 ð 3 Þ where the price of good Y is normalized to unity. Consider next the factor markets. The equilibrium conditions for skilled labor, unskilled labor and capital are: F w ð w S ; r Þ ¼ S ð 4 Þ ð 1 þ m Þ m w ð w U ; r Þ X þ g w ð w R ; r Þ Y ¼ L ð 5 Þ F r ð w S ; r Þ þ m r ð w U ; r Þ X þ g r ð w R ; r Þ Y ¼ K ð 6 Þ where S , L and K denote the amounts of skilled labor, unskilled labor and capital available in the economy. Equations (1) – (6) describe the dual developing economy, which consists of six unknowns, w R , w S , r , m , X and Y . We will use this model to study the effects of partial privatization and foreign competition on the wages of skilled and unskilled labor. In addition, the implications on social welfare will be examined. Wage Inequality In this paper, partial privatization is represented by a rise in the weight k towards profit maximization, while foreign competition is reflected by an increase in the quota on foreign exports Q . Due to monopoly in sector X , changes in k or Q affect the marginal revenue of producing good X and hence the return to capital as shown by equation (1). Letting a circumflex represent a percentage change, these effects can be obtained by totally differentiating equation (1): e b y m KX ^ r ¼ ks ^ k ð 1 s Þð 1 þ kes Þ ^ Q s ½ 1 þ k ð 1 þ es Þ ^ X ð 7 Þ 378 C.-C. Chao et al. where e ¼ 7 p /( X þ Q ) p 0 4 0, being the price elasticity of demand for good X . Note that b ¼ m / p 5 1 and y m jX represents the distributive share of the j th factor in the X ’s variable cost. As indicated by changes in k or Q and X on the right-hand side of equation (7), partial privatization or foreign competition not only directly but also indirectly influences the marginal revenue of producing good X The former causes the MR curve to shift downward, while the latter leads to a movement along the curve via the change in X . Consequently, given the urban unskilled wage, the change in the capital return in equation (7) reflects the change in MR. This then affects the wages of unskilled and skilled labor according to equations (3) and (4), as follows: ^ w R ¼ ð y KY = y LY Þ ^ r ð 8 Þ ^ w S ¼ ^ r ^ S = s F SX ð 9 Þ where y jY represents the distributive share of the j th factor in industry Y and s F SX expresses the substitution effect in the demand for skilled labor in sector X 7 In addition, the change in the rural unskilled wage causes rural – urban migration, thereby affecting the urban unemployment ratio by equation (2): ^ m ¼ ½ð 1 þ m Þ = m ^ w R ð 10 Þ To get the overall changes in the skilled and unskilled wages, we need to obtain the effects of partial privatization or foreign competition on the output of good X Totally differentiating the resource constraints in equations (4) and (5), we have: ð 1 þ m Þ l m LX ^ X þ l LY ^ Y ¼ ^ L ½ð 1 þ m Þ s m LX þ s LY ^ r þ s LY ^ w R ml m LX ^ m ð 11 Þ l m KX ^ X þ l KY ^ Y ¼ ^ K þ ð s m KX þ s KY Þ ^ r s KY ^ w R s F KX ð ^ w S ^ r Þ ð 12 Þ where l m jX and l jY are respectively the employment shares of factor j in industry X ’s and industry Y ’s variable inputs. In addition, s ji captures the effect of a change in the factor prices on the demand for factor j in sector i 8 Substituting expressions from equations (7) – (10) into (11) and (12), we can solve for the effects of partial privatization or foreign competition on the output of good X : ^ X = ^ k ¼ ksA = D < 0 ð 13 Þ ^ X = ^ Q ¼ ð 1 s Þð 1 þ kes Þ A = D < 0 ð 14 Þ where D ¼ s ½ 1 þ k ð 1 þ es Þ A e b y LY y m KX l > 0 by stability and A 4 0. 9 Note that l ½¼ ð 1 þ m Þ l m LX l KY l m KX l LY is positive (negative) if industry X is Rising Wage Inequality in Developing Economies 379 labor intensive relative to industry Y in variable inputs. Hence, regardless of the factor intensity, partial privatization or foreign competition exerts a pressure on the output of good X and the resulting impact on the its price can be obtained by differentiating the inverse demand function of good X , i.e. p ¼ p ( X þ Q ): ^ p = ^ k ¼ ð s = e Þð ^ X = ^ k Þ > 0 ð 15 Þ ^ p = ^ Q ¼ ð 1 = e Þ½ 1 s þ s ð ^ X = ^ Q Þ > < 0 ð 16 Þ Equation (15) states that partial privatization reduces domestic production of good X , thereby raising its price. However, in equation (16), depending on the increase in foreign exports relative to the fall in domestic production, the price effect of foreign competition is ambiguous. Nonetheless, increased foreign competition can raise the domestic price of good X if its domestic supply falls (i.e. 7 d X /d Q 4 1). 10 We are now ready to examine the effect of increased partial privatization or foreign competition on the wages of skilled and unskilled labor. From equation (7), partial privatization or foreign competition in sector X immediately causes a downward shift of its MR curve, and then the induced fall in the production of good X raises the marginal revenue along the MR curve. The total change in MR can be traced in Figure 1 from point a to b and then to point c . The higher MR at point c gives a higher return to capital, which leads to a higher wage for skilled labor but a lower wage for rural unskilled labor. These results on the changes in wages can be obtained by substituting expressions from equations (13) and (14) into equations (7) – (9): ^ w R = ^ k ¼ ks y KY l = D ð 17 Þ ^ w S = ^ k ¼ ð y LY = y KY Þð ^ w R = ^ k Þ ð 18 Þ ^ w R = ^ Q ¼ ð 1 s Þð 1 þ kes Þ y KY l = D ð 19 Þ ^ w S = ^ Q ¼ ð y LY = y KY Þð ^ w R = ^ Q Þ ð 20 Þ Increased partial privatization or foreign competition can lead to a rise in the skilled wage but a fall in the rural unskilled wage, if the urban sector is unskilled intensive relative to the rural sector in variable inputs. In addition, by equation (10), the fall in the rural unskilled wage results in rural to urban migration, thereby giving rise to a higher urban unemployment ratio: ^ m = ^ k ¼ ½ð 1 þ m Þ = m ð ^ w R = ^ k Þ ð 21 Þ ^ m = ^ Q ¼ ½ð 1 þ m Þ = m ð ^ w R = ^ Q Þ ð 22 Þ 380 C.-C. Chao et al. Note that rising wage inequality for the developing economy can be also triggered by the changes in factor endowments. From equations (7) – (12), we have: ^ w R = ^ L ¼ s ½ 1 þ k ð 1 þ es Þ l KY y KY = D < 0 ð 23 Þ ^ w S = ^ L ¼ ð y LY = y KY Þð ^ w R = ^ L Þ > 0 ð 24 Þ ^ w R = ^ S ¼ s ½ 1 þ k ð 1 þ es Þ l LY y KY ð s F KX = s F SX Þ = D > 0 ð 25 Þ ^ w S = ^ S ¼ ð y LY = y KY Þð ^ w R = ^ S Þ < 0 ð 26 Þ ^ w R = ^ K ¼ s ½ 1 þ k ð 1 þ es Þ l LY y KY = D > 0 ð 27 Þ ^ w S = ^ K ¼ ð y LY = y KY Þð ^ w R = ^ K Þ < 0 ð 28 Þ Therefore, from these generalized expressions, which take account of state ownership via the presence of k , either inflows of unskilled labor or Figure 1. Privatization or competition on factor returns Rising Wage Inequality in Developing Economies 381 outflows of skilled labor and/or capital aggravate wage inequality in the economy. In summary, we have the following results. Proposition 1 For a developing economy with a state-owned firm in the urban sector, increased partial privatization or foreign competition can result in rising wage inequality between the skilled and unskilled labor. In addition, changes in the endowments, such as inflows of unskilled labor or outflows of skilled labor and/or capital, can also give rise to the wage inequality in the economy. Social Welfare We consider next the welfare implications of partial privatization and foreign competition for the developing economy, in which social welfare can be represented by the indirect utility function, V ¼ V ( p , I ), where I is national income. Note that national income comes from factor income plus profits of the urban state-owned firm: I ¼ w U L X þ w R L Y þ w S S þ rK þ p Totally differentiating the indirect utility function and then using equations (1) – (6), we obtain the change in social welfare: d V ¼ ð p m Þ dX Qdp w R L X d m ð 29 Þ Equation (29) captures the existence of three distortions in the economy: monopoly power of the state-owned firm, quota restriction on foreign firms, and unemployment in the urban sector. Lowering the distortions can improve social welfare of the economy. Moreover, trade offs can also be worked out. First, the effect of partial privatization on welfare can be obtained from equation (29) as follows: d V = d k ¼ ð p m Þð d X = d k Þ Q ð d p = d k Þ w R L X ð d m = d k Þ ð 30 Þ Since d X /d k 5 0, d p /d k 4 0 and d m /d k 4 0 by equations (13), (15) and (21), we have d V /d k 5 0 in equation (30). Partial privatization unambiguously reduces social welfare because it worsens the monopoly power of the state- owned firm, increases the price of good X and raises the unemployment ratio in the urban sector. Secondly, from equation (29), the welfare effect of increased foreign competition is: d V = d Q ¼ ð p m Þð d X = d Q Þ Q ð d p = d Q Þ w R L X ð d m = d Q Þ ð 31 Þ Although foreign competition reduces domestic output [d X /d Q 5 0 in equation (14)] and raises urban unemployment ratio [d m /d Q 4 0 in 382 C.-C. Chao et al. equation (22)], the welfare effect of foreign competition is, in general, ambiguous because d p /d Q > < 0 in equation (16). However, if the increased imports crowd out more domestic production of good X (i.e. 7 d X /d Q 4 1), we have d p /d Q 4 0 in equation (16) and hence d V /d Q 5 0 in equation (31). The following proposition is immediate. Proposition 2 For a developing economy with a state-owned firm in the urban sector, increased partial privatization or foreign competition can lead to a decrease in the urban output, thereby resulting in the higher goods price and unemploy- ment ratio in the urban area. These effects adversely impact on social welfare in the economy. Conclusions Using a dual structure for depicting a developing economy, this paper has examined the impacts of partial privatization and foreign competition on wage inequality and social welfare. Increased partial privatization or foreign competition can lead to wage inequality between the skilled and unskilled labor. In addition, rising wage inequality can be caused by changes in factor endowments such as inflows of unskilled labor or outflows of skilled labor and capital. Further, partial privatization or foreign competition can reduce the urban output, thereby raising the goods price and unemployment ratio in the urban area. These effects lower social welfare of the economy. The employment and efficiency issues of privatization are not addressed in this paper. Although empirical studies find mixed results on the effects of privatization on employment, production efficiency and profits, 11 it may be worthwhile to consider for future research these issues in the general- equilibrium analysis of privatization. 12 Acknowledgement We are indebted to an anonymous referee for useful comments. The usual disclaimer applies. The work described in this paper was supported by a grant from the Research Grant Council of the Hong Kong Special Administrative Region, China (Project No. CUHK4110/04H). Notes 1 The trade argument for rising wage inequality can be found in Wood (1995) and Leamer (1998), while the technology factor is provided in Francois and Nelson (1998). 2 See Feenstra and Hanson (1996). 3 Neary (2002) examines the effect of increased foreign competition on wage inequality for advanced economies, in which firms are privately owned. Rising Wage Inequality in Developing Economies 383 4 This objective function of profits and welfare for the partially privatized firm is adapted from Matsumura (1998), and is utilized by Chao and Yu (2006) to examine the effect of privati- zation on optimum tariff. 5 For generating some sort of consumer surplus, profits of the public enterprise may be negative. However, public firms can be profit making. Telstra in Australia is a good example of partial privatization: it does not charge monopoly prices and follows the strategy of privatization. This is because the Australian government is very concerned with ensuring services to the rural region and consumers do not pay for telephone services at the true cost of providing them. 6 See Chao and Yu (1997) for a related study. 7 Since the fixed cost of sector X is F ( w S , r ), the elasticity of factor substitution between skilled labor and capital is s F X ¼ FF wr = F w F r . Following Jones (1965), the substitution effect in skilled labor demand is: s F SX ¼ s F X y F KX , where y F KX ð¼ rF r = F Þ is the distributive share of capital in the fixed cost of sector X 8 For instance, s LY ¼ s Y y KY l LY , where s Y ¼ gg wr / g w g r 9 We define A as: A ¼ l LY s KY þ l KY s LY þ y LY l LY s m KX þ ð 1 þ m Þ l KY l m LX 10 From equation (14), we can write: d X = d Q ¼ ð 1 þ kes Þ = ½ 1 þ kes þ ð k e b y LY y m KX l = sA Þ > < 1 if ks > < e b y LY y m KX l = A . Here, the positive l (i.e. the urban sector is relatively unskilled intensive in variable inputs) is a necessary condition for 7 d X /d Q 4 1. 11 For example, Oum et al . (2000) show that the effect of privatization on production efficiency is weak for the airline industry. Using a large cross-sectional sample, Dewenter and Malatesta (2001) also report poor long-run performance of corporations after privatization. 12 We thank for the referee for pointing out that employment, rather than profits, may be another consideration for the public firm. References Chao, C. C. and Yu, E. S. H. (1997) Trade liberalization in oligopolistic competition with unemployment: a general equilibrium analysis, Canadian Journal of Economics , 30, pp. 479 – 496. Chao, C. C. and Yu, E. S. H. (2006) Partial privatization, foreign competition, and optimum tariff, Review of International Economics , 14, pp. 97 – 102. Davis, D. R. (1998) Technology, unemployment and relative wages in a global economy, European Economic Review , 42, pp. 1613 – 1633. Dewenter, K. L. and Malatesta, P. H. (2001) State-owned and privately owned firms: an empirical analysis of profitability, leverage, and labor intensity, American Economic Review , 91, pp. 320 – 334. Feenstra, R. C. and Hanson, G. H. (1996) Globalization, outsourcing, and wage inequality, American Economic Review , 86, pp. 240 – 245. Feenstra, R. C. and Hanson, G. H. (1997) Foreign direct investment and relative wages: evidence from Mexico’s maquiladoras, Journal of International Economics , 42, pp. 371 – 393. Francois, J. F. and Nelson, D. (1998) Trade, technology, and wages: general equilibrium mechanics, Economic Journal , 108, pp. 1483 – 1499. Kar, S. and Beladi, H. (2004) Skill formation and international migration: welfare perspective of developing countries, Japan and the World Economy , 16, pp. 35 – 54. Leamer, E. E. (1998) In search of Stolper – Samuelson linkages between international trade and lower wages, in: S. Collins (Ed.) Imports, Exports and the American Worker (Washington, DC: Brookings Institution). Harris, J. R. and Todaro, M. (1970) Migration, unemployment and development: a two-sector analysis, American Economic Review , 60, pp. 126 – 142. Jones, R. W. (1965) The structure of simple general equilibrium models, Journal of Political Economy , 73, pp. 557 – 572. 384 C.-C. Chao et al. Marjit, S., et al . (2003) Trade and wage inequality in developing countries, Economic Inquiry , 42, pp. 295 – 303. Matsumura, T. (1998) Partial privatization in mixed duopoly, Journal of Public Economics , 70, pp. 473 – 483. Neary, J. P. (2002) Foreign competition and wage inequality, Review of International Economics , 10, pp. 680 – 693. Oum, T. H. et al . (2000) Socially optimal capacity and capital structure in oligopoly: the case of the airline industry, Journal of Transport Economics and Policy , 34, pp. 55 – 68. Wood, A. (1995) How trade hurt unskilled workers, Journal of Economic Perspectives , 9, pp. 57 – 80. Appendix Letting a dot over a variable denote the time derivative, the adjustments of the system in equations (1) – (6) can be expressed as: _ X _ Y _ w R _ r 0 B B @ 1 C C A ¼ s ½ 1 þ k ð 1 þ es Þ 0 0 e b y m KX 0 0 y LY y KY ð 1 þ m Þ l m LX l LY ½ð 1 þ m Þ l m LX þ s LY ð 1 þ m Þ s m LX þ s LY l m KX l KY s KY ð s m KX þ s KY Þ 0 B B @ 1 C C A ^ X ^ Y ^ w R ^ r 0 B B @ 1 C C A The principal minors of the above coefficient matrices are, as follows: D 1 ¼ s ½ 1 þ k ð 1 þ es Þ D 2 ¼ 0 D 3 ¼ s ½ 1 þ k ð 1 þ es Þ l LY y LY D 4 ¼ D The stability condition requires that the odd principal minors are non-positive and the even principal minors are non-negative. Hence, we need: (i) 1 þ es 4 0; and (ii) D 4 0 for stability. Note that 1 þ kes 4 0 since 1 þ es 4 0 and 0 k 1. Rising Wage Inequality in Developing Economies 385

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