Transcript The Harris-Todaro model

The Harris-Todaro Model
If wages were perfectly flexible equal
wages would be paid in industry and
agriculture and there would be no
unemployment
In a perfectly competitive market
For a variety of reasons however workers in
the urban formal sector are paid higher than
equilibrium wages
• Unions
• government policy
• incentives to workers to expend effort when
labor cannot be directly supervised without
tremendous costs.
• The threat being fired. Then one would have
to return to the country or find work in the
urban informal sector.
At the same time, in the rural sector and the informal urban
sector wages rise and fall according to supply and demand.
Such conditions
give rise to the
following:
Here LF workers find employment in good jobs in the cities,
LA remain behind in the countryside working at a lower wage
of wA. Those who migrated from the countryside to the city
find themselves employed in the urban informal sector
As a result, many people end up
in relatively unproductive deadend service sector jobs in the
cities.
Urban overcrowding due to high rates of
migration from rural areas to cities and
high informal sector employment is a fact
of life in many low and middle income
countries. (review table 2.4, page 39)
The Harris-Todaro model helps
to explain this seemingly
irrational phenomenon
First, let’s define real per capita
income in the rural sector:
(PA/P)(QTA/NTR)
Definition of terms
PA=agricultural prices
P=general price level
QTA=total agricultural production.
Next we define urban formal
sector income
wF*n*((NTC-Nu)/NTC)=wFn(1-u)
Definition of terms
WF =the wage paid for good jobs in the
city.
N=the number of hours worked per period
per worker
u=the formal sector unemployment rate
(other terms defined in class).
Finally let’s define urban
informal sector income
WI *n*u
where wI=the wage per hour paid in
the informal sector.
It is sensible to assume that migration
continues as long as urban incomes are
significantly higher than rural incomes.
Or in otherwords migration occurs
when wFn(1-u)+wInu
>k[(PA/P)(QTA/NTR)]
Now think about u, the rate of
unemployment in the formal sector
• (1) The higher U is, the more people there
are actively seeking formal sector
employment that are unable to find it.
• (2) The higher U is the lower the probability
of a new migrant from the country finding a
formal sector job.
• (3) Without a social safety net, he or she
will have to make work for themselves in
the informal sector.
And because of the preceding
wFn(1-u)+wInu
Can be thought of as the wage one
can expect if they move to the city.
And the lower u is the higher the
expected wage
The main point of Harris-Todaro is
that if the expected urban wage ...
• equals rural income there is no incentive to
migrate.
• is greater than rural income there is a great
incentive to move from country to city
• were less than rural incomes there would be an
incentive to move in the other direction. (South
Korea in recent years)
The expected urban wage
depends on what type of
job you land, that depends
on probabilities and these
are linked to current urban
unemployment rate as
defined above.
Therefore to understand the model
set rural and expected urban
incomes equal and solve the above
for u, the urban unemployment rate
U={wFn- (k[(PA/P)(QTA/NTR)]}
/n(WF-WI)
From this result we can show the
following:
•
•
•
•
•
•
U will increase if wF increases!
U will increase if n increases!
U will increase if k drops.
U will increase if QTA/NTR falls.
U will increase if wI increases!
U will increase if PA/P decreases.
One failing of the Harris-Todaro
model assumes migrants are riskneutral
This means that the utility of a
gamble where the payoff is $6000 is
the same as the utility of $6000
guaranteed.
This is not realistic. Especially
poor migrants will be risk averse
This means that to the degree
potential migrants are risk-averse
The less net migration out of rural
areas will be given the gap between
rural and urban wages. Consider k a
measure of the degree of risk
aversion.
Ray’s discussion of social capital
Ray raises an interesting point in
relation to this issue of risk aversion.
He begins by pointing out that
information is high and mobility is
low in rural areas
In other words, every one
knows your business in a
small village and it is hard
to move.
This means that
• In terms of insurance and credit, rural areas
provide a strong support network for the poor (this
is his “social capital”)
• If someone runs into trouble the community
knows why.(If not due to your own negligence
you will receive some support)
• Low mobility also gives rise to “reciprocity”. One
helps others in their time of need knowing that
they will help them in return.
Once migration starts however
This social capital will be eroded and
thus, all else equal, lowers the cost of
migrating since local rural support
breaks down.