We build a version of the quality-ladder growth model with endogenous supply of skills (Dinopou-
los and Segerstrom 1999). A new and key feature of our model is the introduction of heterogeneous
industries. The economy is populated by a continuum of monopolistic competitive industries with
asymmetric innovation power; in the language of quality-ladders models this implies that each sector
has a different quality-jump any time an innovation arrives. In this setting we introduce government
policy, in the form of a public spending rule: the government can allocate its expenditure in manufac-
tured goods using a continuum of different policy rules, from the extreme symmetric rule, where each
sector gets the same share of public spending, to an asymmetric rule, meaning that the sector with
the highest quality jump receives the greatest amount of government spending.
In our model, high-tech sectors are those where innovation brings technological improvements,
quality jumps, that are greater than average. There are two activities in the economy: manufacturing,
carried out by a continuum of asymmetric firms, and innovation activity or production of ideas. We
assume that unskilled labor is used exclusively in manufacturing and that ideas are produced using
only skilled labor. As the government reallocates spending from low to high-tech sectors, aggregate
profits increase. Intuitively, higher quality jumps in high-tech sectors imply higher mark-ups and larger
profits. Hence, a redistribution of public spending in favor of these sectors raises aggregate profits
in the economy. In quality-ladder growth models monopoly profits are the rewards for innovation
activities, so the increase in total profits produced by the reshuffling of public spending will raise the
relative demand for skilled workers.
Finally, there is an education choice in the model that endogenizes skills formation. This implies
that, by increasing the skill premium, high-tech public spending will also raise the incentives to train
and accumulate skills. Therefore, wage inequality generated by our source of technical change will be
a general equilibrium result, where both the supply and the demand for skills are endogenous.
We adopt a broad interpretation of innovation in order to include all of those activities that are
targeted to increase firm profits. In our model, workers performing innovative activities are those
workers that, with their intellectual skills, contribute to give a firm a competitive advantage over
others. Therefore, we do not restrict our view to R&D activities. While R&D workers play an
important role in innovation, they are not the only skilled workforce that a firm needs to beat its
rivals: managerial and organizational activities, marketing, legal and financial services are all widely
and increasingly used by modern corporations to compete in the marketplace.
This paper is related to the literature on skill-biased technical change (SBTC).2 Like other works
in this area, we focus on the role of technical change in affecting the U.S. wage structure in recent
decades. In our paper, innovation is skill-biased by assumption, as in models of exogenous SBTC
(i.e. Aghion, Howitt, Violante 2002, Caselli 1999, Galor and Moav 2000, Krusell, Ohanian, Rios-Rull,
Violante 2000). Strictly speaking, our model is not a model of SBTC in the sense that innovation
does not increase the productivity of skilled workers. In our framework, innovation is simply a skill-
intensive activity, and wage inequality increases with the size of this activity. The innovation activity
just described implies that technical change in our model is endogenous, as in models of endogenous
2For a review of this literature see Acemoglu (2002), Aghion (2002) and Hornstein, Krusell, and Violante (2005).