Institutional quality and skilled-unskilled wage inequality

•We establish two-sector general equilibrium models.•We investigate how an institutional quality improvement influences the wage inequality.•We find that an improvement of the institutional quality affects the interest rate.•The interest rate and the capital intensity generate an impact on the wage inequality.•Our findings are still robust in the extended models.

This paper establishes two-sector general equilibrium models in the presence of unproductive activities to investigate how an improvement of the institutional quality influences the skilled-unskilled wage inequality. We find that an improvement of the institutional quality will affect the interest rate, and then the interest rate combining with the capital intensity will generate an impact on the skilled-unskilled wage inequality. Specifically, both the interest rate and comparisons of the capital-labor relative distributive shares between two sectors play an important role in determining the skilled-unskilled wage gap in an economy featured with unproductive activities. The above results are robust even when we extend the basic theoretical model in several different ways.