Wage inequality in a dual economy and international mobility of factors: Do factor intensities always matter?

The paper develops a three-sector specific factor model with Harris-Todaro type unemployment to examine the consequences of international factor mobility on the skilled-unskilled wage inequality and urban unemployment of unskilled labour in a small open dual economy. The theoretical analysis shows that the consequences of international factor mobility on wage inequality may not necessarily depend on the difference in the factor intensity condition. Only when the unskilled wage in the low-skill urban sector is positively related to the rural wage, factor intensity conditions do matter. An emigration of skilled labour or an inflow of foreign capital may move the wages in favour of the unskilled labour and lower the magnitude of urban unemployment only if the low-skill urban sector is capital-intensive (in a special sense). But, an immigration of unskilled labour produces exactly the opposite effects. The paper argues that provided the government undertakes supplementary measures to curb trade union power and prevent illegal immigration of unskilled labour, abundant inflows of foreign capital might be a solution to both deteriorating wage inequality and increasing unemployment of unskilled labour in the liberalized regime.