Economic recession, efficiency wage and skilled unemployment: A theoretical analysis

A three sector specific factor competitive general equilibrium model is developed for a small open economy where unemployment of skilled labour is explained using Efficiency Wage Hypothesis (EWH). In this model efficiency of a skilled worker, which is specific to high skill urban sector, varies positively with its wage and the unemployment rate. Using such a framework we have examined the impact of economic recession on skilled-unskilled wage inequality and skilled unemployment of the economy. We have also analysed the effect of recession on social welfare by considering Gini-coefficient and welfare measure of Sen (1974). The analysis finds that economic recession improves the average unskilled wage of the economy as well as the skilled-unskilled wage gap, but economy-wide effective skilled unemployment might get reduced. Finally it is observed that the impact of recession on Gini-coefficient is indeterminate and, interestingly, overall social welfare and wage inequality might not move in the same direction.