The article investigates the effects of secondary (including vocational) and higher-education subsidies on wage inequalities between skilled, semi-skilled and unskilled workers, and unemployment in a small open developing economy in terms of a two-sector Harris–Todaro dynamic general equilibrium framework. The results show that skilled–unskilled and skilled–semi-skilled wage inequalities depend on factor intensity conditions, while semi-skilled–unskilled wage inequality is determined by the level of skill formation in the economy. There is a trade-off between the wage inequalities of skilled–semi-skilled and semi-skilled–unskilled workers due to secondary education subsidy; the trade-off also exists with respect to higher-education subsidy if the manufacturing sector is more skilled labour intensive. However, if the manufacturing sector is capital intensive, higher-education subsidy is detrimental for both types of wage inequalities in the initial years of skill formation but might have favourable effects when the skill endowment is high. Both types of subsidies reduce unemployment in the initial periods, but higher-education subsidy accentuates it when skilled labour supply expands in the economy.
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