(For an updated version of this working paper, see WP 06-10)
Does capital-embodied technological change play an important role in shaping labor market inequalities? This paper addresses the question in a model with vintage capital and search/matching frictions where costly capital investment leads to large heterogeneity in productivity among vacancies in equilibrium. The paper first demonstrates analytically how both technology growth and institutional variables affect equilibrium wage inequality, income shares and unemployment. Next, it applies the model to a quantitative evaluation of capital as an origin of wage inequality: at the current rate of embodied productivity growth a 10-year vintage differential in capital translates into a 6 percent wage gap. The model also allows a United States-continental Europe comparison: an embodied technological acceleration interacted with different labor market institutions can explain a significant part of the differential rise in unemployment and capital share and some of the differential dynamics in wage inequality.