Working Paper

Inequality and Employment

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“Natural rate theory” has dominated interpretations of economic trends and policy prescriptions over many decades. European-type welfare state institution were claimed to cause a compressed wage distribution that distorts otherwise well functioning labor markets.

Trans-Atlantic patterns seemed to support the “natural rate theory”: high and rising unemployment with “low inequality‟ in Europe contrasted with the “great American job machine‟ with a much wider wage distribution. Interpreting high and rising wage dispersion in the US as market response to technological change and/or globalization the way to move seems to be clear: shrink welfare state institutions, allow for rising inequality and employment in Europe will rise. “Natural rate theory‟ got almost universally accepted directing the attention to labor market institutions and discarding macroeconomic differences as potential causes for diverging transatlantic employment trends.

This paper first discusses the relation between skill structure and wage distributions, it then investigates the claim that inequality creates incentives that facilitate human capital formation. The “big tradeoff‟ between efficiency and inequality is discussed it is argued that redistribution –especially when improving access to educational services- lays the ground for human capital investment rather than impeding it. Learning causes learning and better education results in more flexible labor force generating a dynamic economy. Finally, the relation between redistribution and employment analyzed.