Since 1975 labour slack has been unusually high in the OECD countries, and yet inflation has not diminished. The less favourable mix of unemployment and rate of change of inflation (which we call stagflation) is explained by a fall in the feasible rate of growth of real wages unmatched by a reduction in the constant term in Phillips curve. To investigate this mechanism, conventional wage and price equations are estimated for 19 countries and then used for simulation. Stagflation has been caused in roughly equal amounts by rising relative import prices and by the fall in the rate of productivity growth. In the basic model the Phillips curve is assumed not to adapt to falls in feasible real wage growth, but in a final section an adaptive wage equation is estimated, which confirms that the process of adaptation is slow.

This article presents evidence for the view that physical capital is more complementary to educated labor than to less educated labor. For this reason previous estimates of elasticities of substitution between educated and less educated labor are too high. Using a two-level CES production function, we run international cross-sectional regressions at the level both of the economy and of individual sectors. The whole-economy model allows for the effects of wages on educational choices as well as vice versa. It predicts that, as total capitalper head rises, the share of physical capital in national income falls and that of human capital rises. The production function also shows that intercountry differences in output per head are due more to differences in physical capital than in human capital.