Human Capital Externalities, Migration, and Wage Inequality

Abstract This paper explores the impacts of human capital externalities on rural-urban migration and skilled-unskilled wage inequality. In the basic model with full employment, an increase in the intensity of human capital externalities will increase migration, and reduce wage inequality if the skilled sector is more capital intensive than the unskilled sector. The results of the basic model remain robust under various conditions, which include the incorporation of human capital externalities in the rural sector into the model, the use of the average human capital level to represent human capital externalities in the urban area. When there is an urban minimum wage in the economy (irrespective of whether an informal sector exists or not), wage inequality will be conditionally decreased, but the impact on migration remains unchanged. This also applies when human capital externalities affect skilled and unskilled sectors differently. In the case of a partially open capital market in the economy, migration will still be encouraged, yet wage inequality will be widened.