Government spending composition, technical change and wage inequality



provided by Research Papers in Economics

Government Spending Composition, Technical Change and Wage
Inequality

Guido Cozzi*       Giammario Impullitti^

This version: December 2008

Abstract

In this paper we argue that government spending played a significant role in stimulating the
wave of innovation that hit the U.S. economy in the late 1970s and in the 1980s, as well as the
simultaneous increase in inequality and in education attainment. Since the late 1970’s U.S. policy
makers began targeting commercial innovations more directly and explicitly. We focus on the shift
in the composition of public demand towards high-tech goods which, by increasing the market-size
of innovative firms, functions as a de-facto innovation policy tool. We build a quality-ladders non-
scale growth model with heterogeneous industries and endogenous supply of skills, and show that
increases in the technological content of public spending stimulates R&D, raises the wage of skilled
workers and, at the same time, stimulates human capital accumulation. A calibrated version of the
model suggests that government policy explains between 12 and 15 percent of the observed increase
in wage inequality in the period 1976-91.

JEL Classification: E62, H57, J31, 031, 032, 041.

Keywords: R&D-driven growth theory, heteregeneous industries, fiscal policy composition,
innovation policy, wage inequality, educational choice.

1 Introduction

In the early 1980s we observe a substantial increase of public investment in high-tech sectors in the U.S.:
investment in equipment and software (E&S), which was 20 percent of total government investment
in 1980, climbs to about 40 percent in 1990 and to more than 50 percent in 2001.1 The composition
of private investment also switched towards E&S but more than a decade later, catching up with the
public trend in the 1990s (NSF 2002). Accompanying this acceleration of the technological intensity
of public spending we observe an 18 percent increase in the relative wage of skilled workers during the
1980s (CPS 1999).

In this paper we argue that the change in the composition of public spending reallocated market-
size from low-tech to high-tech industries, thus enlarging the market for more innovative products
and stimulating innovation. As innovation is a skill-using activity, government policy may have also
helped to stimulate the relative demand for skills and raise the skill-premium. Our analysis remarks
that although government procurement is not an explicit policy tool, it has often worked as ‘de facto’
innovation policy instrument.

*Guido Cozzi, Department of Economics, University of Glasgow. Email: [email protected]
tGiammario Impullitti, Department of Economics IMT Lucca Institute for Advanced Studies. Email:
[email protected]

1 E&S includes a group of investment goods that are considered more innovative than those included in structures
(see Cummins and Violante 2002 and Hob jin 2001b).



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