Skill heterogeneity and market labour income inequality

Occupational choice models predict that, ceteris paribus, countries with higher dispersion of skill will have higher market labour income inequality. However, an extended conclusion from empirical research is that cross-country variations in dispersion of skill explain little of the variation in income inequality. This paper identifies factors related to production and organization technologies that moderate the relationship between dispersion of skill and dispersion of income in occupational choice equilibrium outcomes and that, if not properly accounted for, can bias the results of the empirical studies that explain dispersion of income as a function of dispersion of skill. In particular, comparing equilibrium outcomes from occupational choices in economies that differ in the distribution of skill and in the efficiency of supervision hierarchies, the paper can explain why the US and Sweden have similar labour productivity, but income inequality is higher in the US than in Sweden, and why productivity is lower and income inequality is higher in Spain than in Sweden.