Bounding Cross-Country Human Capital Variation

This paper explores a possible limitation of generalized human capital models that operate by relaxing the assumption that skilled and unskilled labor are perfect substitutes. We make use of the notion that, when skilled and unskilled labor are rather inelastic, countries with relatively few skilled workers should offer large skill premiums compared to countries where skilled labor is relatively abundant. We introduce the a priori assumption that the price of skilled labor should be higher in developed countries than in undeveloped ones, and see that as skilled and unskilled labor become increasingly inelastic, generalized human capital models can attribute the majority of cross-country income differences to human capital variation only at the cost of violating this a priori assumption. We argue that this implies a bound on the substitution elasticity between skilled and unskilled labor that effectively bounds the contribution of human capital to cross-country income differences. This supports the notion that a theory of Total Factor Productivity is necessary to explain income variation across countries.Bachelor of Art