Wage Inequality in the Presence of Environmental Pollution and Skill Formation: A Theoretical Analysis

We develop a static three-sector competitive general equilibrium model of a small open economy with four factors. Skilled labour, unskilled labour, capital and land are the three primary factors of production. Pollution permits also play an essential role in the study. We use pollution permits here as an input for production in the manufacturing sector along with capital and skilled labour. The agriculture sector uses unskilled labour and land as inputs. We also consider an endogenous skill formation sector which transforms unskilled labour into skilled labour with the help of skilled labour and capital. We study the impacts of foreign capital inflow and pollution control on skilled-unskilled wage inequality and the skill formation sector.