Public Expenditure on Pre-tertiary and Tertiary Education: Effects on Skilled–Unskilled Wage Inequality

Due to increased governmental recognition of importance of human capital formation coupled with their egalitarian goal to reduce inequalities, differential public allocation to pre-tertiary (primary and secondary) education and tertiary (higher) education is a pertinent issue. The paper analyses the effects of government subsidy on pre-tertiary and tertiary education, on skilled–unskilled wage gap in the economy. A three-sector full-employment model is set up. There is endogenous skill formation, whereby unskilled and skilled labour supply are determined by intertemporal utility maximizing behaviour of the households. Comparative static analysis indicates that both subsidies on pre-tertiary and tertiary education are beneficial for reducing wage inequality irrespective of the level of skill formation if the low-skill sector is more capital intensive vis-à-vis the high-skill sector. However, if the high-skill sector is more capital intensive, subsidy on tertiary education subsidy may reduce the skilled–unskilled wage inequality only when the skilled labour stock is higher, while pre-tertiary education is likely to be favourable during the period of skill formation only if the returns to education are sufficiently high. The government policies pertaining to public expenditure on education should take into account the relative factor intensity conditions and the level of skill formation in the economy.