Service Sector Expansion, Skill Premium and Welfare Inequality

Data shows that, compared with other industries, service industry has higher income elasticity of demand, higher skill intensity. Therefore, the expansion of service industry not only is accompanied by the adjustment of consumption structure of different income groups, but also affects the supply and demand of and hence income gap among workers with different skill. By building and calibrating multi-country multi-sector model with input-output linkage and non-homothetic preference, this paper finds that the expansion of service industry would increase the skill premium and welfare inequality. However, due to the continuous influence of college enrollment expansion, the increase in supply of high skill labor reduces the income and welfare inequality, which offsets the effect of service industry expansion. In addition, given the doubling of China’s real GDP, manufacturing biased technology progress curbs the welfare inequality while the service biased technology progress raises the welfare inequality. But the latter can improve the welfare more than the former. Finally, this paper figures out that the social welfare rises as the trade cost of modern service declines, the employment size, skill premium and welfare inequality present a U-shape evolvement. This paper reveals that, service industry expansion is faced with the trade-off between “efficiency” and “inequality”, no matter whether it is driven by the relative technology progress across sectors or further openness.