Rural to Urban Lecture 17 - University of Wisconsin–Madisonwalker/wp/wp-content/uploads/2012/09/e… · Agriculture The ICRISAT Villages Rural{urban interaction Two fundamental

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Rural–urban interactionRural–urban migration

Rural to UrbanLecture 17

October 30, 2012

Rural to Urban Lecture 17

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OverviewThe structural viewpointFormal and Informal urban sectorsAgricultureThe ICRISAT Villages

Rural–urban interactionTwo fundamental resource flowsThe Lewis Model

Rural–urban migrationIntroductionThe basic modelFloors on formal wages and the Harris–Todaro equilibrium


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The structural viewpointFormal and Informal urban sectorsAgricultureThe ICRISAT Villages

Structural viewpoint

We expect uneven growth and development. Some regions andsome sectors of the economy will develop first and grow fastest.

This structural transformation is an integral part of developingcountries.

To study it, must disaggregate economy and look at individualmarkets, sectors.

Yet, must remember that markets are tied. And none operation infull isolation of the others.


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Agricultural sector

The agricultural sector is typically the largest. Though represents alarger share of the population than it does the share of income.Poverty widespread.

Most people in rural areas connected in agriculture — land owner,farmer, tenant farmer, hired labor, supplier, etc.

Makes sense to study rural areas first.


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Formal and informal urban sectors

The existence of a nontrivial informal sectors is a unique feature ofdeveloping economics.

Formal sector where workers and firms operate under accepted setof rules (laws) and regulations imposed by the government.

Workers are sometimes unionized.

Firms are required to pay minimum wages, conform to safetystandards, provide pensions, etc.

Firms pay taxes.


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Formal and Informal urban sectors

Formal sector bears close resemblance to economic activity indeveloped countries.

Firms have records and firms are relatively tangible entities.

Can issue shares of stock, pay dividends, they can be audited,protected by bankruptcy laws of country.

Entry into formal sector is costly — thus expect firms of aminimum size to needed to cover setup costs (paperwork of legalentity).


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Informal Sector

A alertloose amalgam of small scale organizations that escape thecover of many of the regulations of the formal sector and do notreceive access to privileged facilities.

No minimum wage, no retirement plans, no unemploymentinsurance, no safety regulations.

Generally do not pay taxes and receive no government support.

Costly to monitor and enforce regulations so governments “lookthe other way”.


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Informal Sector

Firms in this sector exist in a shadowy penumbra.

Yet, enormous fraction of labor force works within the informalsector.

Usually small scale operations. Setup costs are low. Advanced taxpayments unnecessary, though occasional bribe may be needed.


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Agriculture

Tax authorities have no way to observe how much output a farmerproduces, so output is untaxed.

Income is taxed in U.S.

Rural areas in developing countries typically do not have publicpension programs, minimum wages, unemployment insurance . . .

But, a collection of informal institutions creates substitutes for themissing sources of support.


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Organization

Production is organized in a variety of ways.

I Family farms. Own consumption and cash crops.

I Large ownership cultivators (corporate farms).

I Tenant farmers (lease land from landowner)

I Labors work for wages or commission on the land of others.

I The landless.


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the ICRISAT Villages

Useful example of agricultural villages in India.

Read on your own


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Two fundamental resource flowsThe Lewis Model

Rural–urban interaction

This section offers a historical perspective on theories ofdevelopment economics.

Describes two fundamental resource flows.

Presents the Lewis Model.

Arthur Lewis shared the Nobel Prize with T.W. Schultz in 1979.


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Two Fundamental resource flows

Two critical resource flows from agricultural sector:

1. Food. Agriculture must produce food needed by urban sector.

2. Labor the supply of labor for industry comes from theagricultural sector.

Thus, the agricultural sector has important effects onnon–agricultural sector.


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The Lewis Model

Most important concept: dual labor markets

Dual in the sense of non–competing.

The idea of dual labor market is important, no one (except Ray)uses the Lewis Model.

So we will skip the Lewis model and you are not responsible for thematerial.


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IntroductionThe basic modelFloors on formal wages and the Harris–Todaro equilibrium

Rural–urban migration

We observe:

1. Large wage gap between rural and urban sectors. Wages highin urban sector.

2. Unemployment in urban areas.

Basic model: Harris and Todaro applied to generate this pattern.


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Basic Model

Assume migration is costless.

I Width of Fig10.4 size of labor force

I Formal “F”, Agricultural “A”

I AB labor demand formal

I CD absorption of labor in Agriculture (labor demand)

I With flexible wages equil at w∗, L∗F , L∗A


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Equil w Flexible WAgricultural wageFormal Wage

w*

L*f L*A

A

B

C

D


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Equilibrium with Flexible Wages

Equilibrium requires that the “law of one price” hold.

Same wage holds in formal and agricultural market. Otherwisehave persistent migration to arbitrage the difference.


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Formal Wages Inflexible

Wages in formal sector inflexible:

I May be more unionized than agricultural sector.

I Showcase for government policy — minimum wage, pension,unemployment insurance

I Firms in Formal sector may pay a premium — seek bestworkers

Wages in informal and agriculture flexible and adjust to S and D.


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Floors on Formal Wage

I Wage in formal sector at w̄

I Reduce labor demand in formal sector.

I Full employment requires agricultural wage at w

I Can not be equilibrium. Workers will migrate to Urban.

I If wages at w̄ employment in agriculture declines.

I Have unemployment U.

I Unemployed must be in Urban area, otherwise driveagricultural wage down.


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Figure 10-5Agricultural wageFormal Wage

Lf

U

LA

Wbar

wbar


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Equilibrium

I Rigid wage in Urban formal sector thus produces anequilibrium in which workers voluntarily migrate from rural tourban areas.

I But face some chance of unemployment in Urban area.

I Unemployment equilibrates the market.

I Worker choices: be employed in agricultural market for lowwage or move to city and gamble on securing high wage.


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Harris Todaro Equilibrium

I Probability of getting job in urban area depends on ratio ofvacancies to job seekers.

I Let p be the probability obtaining job in formal sector.

I Let wI be the wage in the urban informal sector. Fixed.

I Expected wage in urban sector: E [wu] = pw̄ + (1− p)wI .

I Equilibrium: E [wu] = wa.

I Equilibrium requires p = L̄FL̄F +LI

If employment in informal sector probabilistic:

E [wu] = pw̄ + (1− p) q wI .


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Harris Todaro Eq

I People indifferent ex ante stay or leave.

I Ex post not indifferent.

I A particular allocation of labor an equilibrium: p = f (LF , LI ).

I Extend to many sub sectors of urban market key: E [wu] = wa.


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Government Policy

The informal sector an outgrowth of the formal sector, slows thepace of rural–urban migration.

Yet unregulated economic activity often responsible for congestion,pollution, crime.

Government policy: accelerate absorption of labor into formalsector. Via subsidies (tax holidays), increase employment in publicsector.

Immediate effect increase in demand in formal sector, w̄ ↑ . AndL̄F ↑ . Hence, E [wu] ↑ .

But can not persist. Increased gap between E [wu] and wa inducesmigration to city.


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Government Policy

Increase flow to city reduces chance of getting job in formal sector,while outflow from rural area increases wa.

Eventually, obtain new equilibrium.

w̄ ′Fw̄ ′F + L′I

w̄ +L′F

w̄ ′f + L′I= w ′a

For E [w ′u] > E [wu] require share of formal sector must increase:

w̄ ′Fw̄ ′F + L′I

>w̄F

w̄F + LI


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Government Policy

Policy increased share of employment in formal sector.

Reduced share of employment in informal sector.

Yet, total size of informal sector may increase. True, if total urbansector increases more than formal sector.

Commonly seen: attempts to increase the demand for labor in theformal sector may enlarge the size of the informal sector, asmigrants respond to the better job conditions. Migration effectmay dominate the initial “soak–up effect.”

Not confined to employment — any enhancement that attempts toreduce congestion, pollution, improve health care might have effectof finally worsening these indicators. Todaro paradox


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Efficient Allocation and Migration Policy

Think of competitive labor market with flexible wages.

Then absorption curves demand curves andw = VMP = pproductMPL.

With flexible wages wu = wa so fully efficient.

Harris Todaro: w̄ > wI . Increase efficiency by moving worker frominformal to formal sector.

Have policy to restrict migration (if possible) to only those withjobs in formal sector.

Employment in formal sector L̄F . Everyone else, LMA , in agriculture.


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Eliminated Informal Sector

But compared to fully flexible wages, have too few people in urbanarea, social loss from misallocation of resources.


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Rural to Urban Lecture 17 - University of Wisconsin–Madisonwalker/wp/wp-content/uploads/2012/09/e… · Agriculture The ICRISAT Villages Rural{urban interaction Two fundamental